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Circuit Breakers Explained

Circuit Breakers Explained

March 20, 2020
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Over the past few weeks, investors may have been introduced to a new term they weren’t previously familiar with: circuit breakers. Today, we answer a few simple questions about circuit breakers:

What is a circuit break? A circuit breaker is a built-in temporary halt or momentary pause in trading in the stock market.

What are the triggers for a circuit breaker? There are three levels, or thresholds, at which trading will pause, and they are based on movement in the S&P 500 Index. Level 1 occurs when the S&P 500 declines at least 7% from its closing price the day before. Level 2 occurs if the index drops 13% from its close the prior day. After each Level 1 and Level 2 threshold is reached, trading pauses for 15 minutes. If the index ever drops 20% from its prior day’s close, the Level 3 circuit breaker is enacted, at which point trading is discontinued for the rest of the day. Circuit breakers do not apply to strong upward moves in prices.

What is the point of circuit breakers? The original intent of circuit breakers was to stop a market in free fall or prevent panic selling. By halting trading for a set amount of time, investors ideally can reassess market conditions. But the time also allows investors to understand what’s happening in the market, for example in the event of an impactful midday news break.

Three Level 1 circuit breakers have been triggered over the past two weeks: March 9, March 12, and most recently on Monday, March 16. It’s also important to note that some traders have questioned the efficacy of circuit breakers since then, given that they occurred early in trading and lower prices were not likely to have been a surprise to investors those mornings as stocks gapped signifcantly lower. Nevertheless, circuit breakers remain an intentional aspect of the stock market, and ideally give time for buyers and sellers to be matched up more efficiently.

 

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