What Are Stock Market Circuit Breakers?

When market volatility hits extreme levels, stock exchanges use circuit breakers to calm trading activity and prevent panic selling. These are automatic trading halts triggered by sharp market declines.

The break gives traders a chance to digest any new information that may be spreading through the equity market, potentially preventing rash and panicky decisions that could exacerbate losses and extend volatility. It also gives potential buyers time to emerge.

Circuit breakers were added to the exchanges' toolkits in the aftermath of the 1987 Black Monday crash. Since then, they have been triggered by three major events in the last 24 years: the 2001 attacks on the World Trade Center, the 2008 financial crisis, and the 2020 COVID-19 outbreak.

Over the years, circuit breakers have been refined to reflect changes in trading volumes and the greater magnitude of price movements. The objective hasn't changed, however: to help markets remain efficient despite swirling emotions.

A circuit breaker is a market mechanism designed to reduce panic sell-offs and encourage orderly trading. In the event of a significant decline in the S&P 500^® index (SPX) from the previous day's closing price during the regular trading session (9:30 a.m. to 4 p.m. ET), trading on equities and options halts for 15 minutes or for the rest of the trading day—depending on the severity of the drop and the time at which it occurs. The level of decline is marked by a three-tier system.

Current market-wide circuit breakers are set as follows:

• Level 1: 7% decline before 3:25 p.m. ET, trading halts for 15 minutes. If it occurs after that time, trading does not halt.
• Level 2: 13% decline before 3:25 p.m. ET, trading halts for 15 minutes. If it occurs after that time, trading does not halt.
• Level 3: 20% decline at any time of day, trading halts for the remainder of the day.

A Level 1 or Level 2 halt can only occur once per trading day—so, if trading is halted once due to a 7% decline, prices must fall 13% before a second halt will be implemented.

Circuit breakers are rare, with the most recent round of circuit breakers occurring at the start of the COVID-19 pandemic on March 9, 12, 16, and 18 of 2020 as the equity market—and the public at large—worked out the potential effects of the illness, the lockdown, and government responses to the situation.

When the thresholds are tripped, securities cannot be bought or sold until the halt is lifted. Traders and investors have a few minutes to take a step back and consider how they want to respond. For example:

• Is this a great time to buy?
• Can prices go lower?
• Are hedges a good idea here?
• Is holding the best option?

Trading is sometimes halted for reasons other than price declines. For example, the exchanges occasionally experience technical outages or electrical shorts. When this happens, trading resumes as soon as the problem is fixed.

Another regulatory trading curb is the LULD, short for Limit Up/Limit Down. It's like a circuit breaker for an individual stock and is designed to avoid extreme volatility by keeping trades within a specified range.

If a stock's price breaks a certain level for 15 seconds, trading halts for five minutes. The levels are determined by percentage bands that are set above and below a reference price, which is the average price of a security over the previous five minutes. The size of the band is determined by tiers, assigned based on the stock's index and market price.

Tier 1 includes all stocks in the SPX, Russell 1000^®, and select exchange-traded products.

• If the stock price is greater than $3, the bands are set at 5% up and down.
• Bands for stocks priced between $0.75 and $3 are set at 20%.
• Stocks below $0.75 have bands set at 75% or at 15 cents, whichever is lower.

Tier 2 includes all other stocks traded on the National Market System, which includes all entities and facilities used by broker-dealers to execute trades.

• The bands for stocks greater than $3 are 10%.
• Bands for stocks priced between $0.75 and $3 are set at 20%.
• Stocks below $0.75 have bands set at 75% or at 15 cents, whichever is lower.

The LULD price bands are continuously calculated on a rolling five-minute average, and they are doubled for both tiers during the last 25 minutes of trading. If a pause occurs in the last 10 minutes of the trading session, the security will not be traded for the remainder of the trading day.

Separately, exchanges may also institute security-specific trading halts in anticipation of a news announcement that has the potential to cause a drastic stock move in order to give investors time to absorb the information. These are perhaps the most common type of trading curb.

The Black Monday crash of October 1987 didn't have a specific fundamental cause. Many factors contributed, including a rise in the use of options and derivatives that accelerated initial losses, as well as settlement timelines in various markets, according to the Federal Reserve. To a large extent, a feedback loop exacerbated it: The equity market fell, causing some traders to get scared and sell stock, which took prices down further and caused more traders to get nervous. In the aftermath, the New York Stock Exchange (NYSE) proposed a system of circuit breakers that would pause trading in response to extreme volatility.

The original stock market circuit breakers set in 1988 called for a one-hour halt after a 250-point decline in the Dow Jones Industrial Average^® and a two-hour halt after a 400-point decline, both on a single day of trading. Over time, the rules evolved to express the circuit breaker thresholds as percentage changes, to use the S&P 500 instead of the Dow Jones, and to include all exchanges, not just the NYSE.

Stock markets outside of the United States have their own systems of circuit breakers, with the same underlying rationale: allowing a pause in the trading day to calm nerves in periods of extreme stress.

Circuit breaker rules and LULD halts have the same purpose: To create a little breathing space in an extremely volatile equity market to prevent panic and give participants time to digest news events. The hope is that when trading resumes, the market will be a little more rational and a little less emotional. These trading halts are rare. The best investor response is to review trading plans in light of the news.