The share prices of a company are controlled by various prominent factors such as interest rates, earnings of the company, government policies, financial results, management policies and so on. The greed and fear of the investors or speculators also sometimes may lead to the drastic movement in the share prices. Such high volatility is extremely harmful and can create panic in the stock market. In order to safeguard the interest of the investors, Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) as per the guidelines of the Securities and Exchange Board of India (SEBI) have come up with a mechanism, which is known as the circuit filter. It is also called as a circuit breaker.
Here is what you need to know about this mechanism and why they are important.
What is a Circuit Filter and How it Works?
A circuit filter is basically a price band, which is levied by the SEBI to curb the excessive movement in the stock prices. A price band is essentially a limit beyond which the prices of the shares are restricted to move on a particular day. It restricts the extreme price movement and manipulation carried out by the stock operators. A very important point that must be taken into the consideration is once the circuit filter has been applied, and then no order can be placed. If there are any existing orders with the brokers, then it can either be modified or canceled.
The stock exchanges place the price bands with the upper and lower circuits within which the stock prices are not allowed to move in a particular day. Any upward movement of the share prices beyond the set price band is called as an upper limit. Similarly, any downward movement of the share prices beyond the stipulated price band is called as a lower limit.
For example, if a share price of a company is Rs 200 and there is a circuit breaker of 10%, then its trading will be halted id the share price goes above Rs 210. Similarly, if the share price decreases below Rs 100, then the lower end circuit will be applied by the stock exchanges and trading is suspended.
Importance of Circuit Limits
The circuit filters help in preventing the high stock volatility if there is excessive movement in the share prices. For example, in its annual report, if a company reports higher revenue loss, then there is a high percentage of chances that this may create panic among the investors and start selling the shares. This may lead to an excessive volatility in the share prices. By using the circuit limit, it is actually possible to avoid panic among the investors.
Circuit Limit for Stock Exchanges
There are three circuit limits for the stock exchanges i.e. 10%, 15% and 20% that had been defined by the SEBI. The filters are applied to the Sensex or Nifty whichever breaches the price limit first. The effects of the filters largely depend upon the time at which it takes place. The details are mentioned below:
10% Circuit Limit
- If there is movement in share prices before 1 P.M – Trading is halted for 1 hour.
- If the movement of the share prices is after 1 P.M but before 2.30 P.M – Trading is halted for an hour.
- If the movement of the share prices is after 2.30 P.M – Trading is not halted.
15% Circuit Limit
- If the movement of the share prices is before 1 P.M – Trading is halted for 2 hours.
- If the movement of the share prices after 1 P.M but before 2 P.M – Trading is halted for 1 hour.
- If the movement of the share prices is after 2.30 P.M – Trading is halted for rest of the day.
20% Circuit Limit
If there is 20% movement in the share prices either in Nifty or Sensex, then the trading is halted or suspended for rest of the day.
How Circuit Limits are calculated?
The stock exchanges are required to calculate the circuit limits on a daily basis. The limit percentages are calculated on the closing index value of the previous day. The circuit limit is calculated on the opening price of the stock. For example, if the price of a share is Rs 100, then its price will be Rs 110 if it breaches the 10% price band limit. After the market hits 10% again, there will no halt, but if it reaches 15%, then 5% will be calculated on Rs 110 that will be 115.5. Again after the resumption, if the market hits 20%, then the 5% will be levied on the 115.5, which will be Rs 122 and trading will be halted for the rest of the day. It is important to note that the circuit limit is not imposed on the shares, which have futures and options contracts. This means that the trading will not get suspended if the prices of the shares with derivatives increase more than the highest circuit limit of 20%.
The Closing Words…
From the above discussion, it is crystal-clear that the circuit filters go a long way in preventing the anxiety or panic among the customers. The BSE and NSE review the circuit limit filters on a continuous basis. If it is found that a particular stock has become less volatile over a period of time, then the stock exchanges may exclude the that stock from the circuit filter limit. All in all, the circuit limit are blessing in disguise for the investors as it helps them to safeguard their interest and hard-earned money.