From record highs to the recent bear market lows, the financial markets have had volatile intraday swings last seen in the financial crises. Circuit breakers have been working overtime in the Futures and Cash markets with new terms like “Limit Up and Limit Down” reaching the airwaves.
Emotions drive the markets which is evident with the widespread fear the coronavirus (COVID-19) has inflicted on the global economy and we might be in for a lot more pain with a second wave of infection on the cards.
Let’s take a closer look at what “circuit breakers”, “Limit Up” and “Limit Down” means to a trader:
To put it simply, circuit breakers are measures imposed by regulators to temporarily halt trading on an exchange to try and curb panic selling or even buying. Circuit breakers are triggered automatically when price drops and hits predetermined intraday levels set by regulation such as 7%, 13% and 20%.
During non-U.S trading hours hard limits, up and down of 5% are imposed and when this session ends and turns into the main session the first level circuit breaker changes from 5% to 7%.
Circuit breakers apply to the Futures market, the broad-based market Indices and securities in the U.S and in other countries around the world like South Africa.
This term refers to buying being suspended of a Futures contract after it has reached its 5% threshold in the out-of-hours trading session. Trading might be halted until the main session starts which will see traders locked in that position until trading resumes by the exchange. Different Futures contracts can have different price limit rules set out by the regulator.
If the Limit Up threshold of 7% is breached in the main session and the circuit breaker is triggered, trading will be suspended for 15min to try and curb volatility.
This is more of a concern than “Limit Up” and refers to the maximum price decline of a stock or Futures contract in a single session. Selling is suspended every time the circuit breakers are triggered across the following three levels versus the previous day’s close.
- Level 1 - a decline of 7%. Trading is halted by exchange for 15 min.
- Level 2- a decline of 13%. Trading is halted by exchange for 15 min.
- Level 3- a decline of 20%. Trading is halted by exchange for the rest of the day’s session.
Limit Down levels seek to curb panic selling which can lead to market crashes which can occur due to the price of the underlying decrease in line with increased supply and lower demand in the market.
Trading while a circuit breaker is triggered
When these circuit breaker levels are breached the exchange will suspend trading and traders with open positions will unfortunately be stuck in those positions until trading resumes once more.
When trading resumes, we might see “price gaps” in the market in either direction due to high volatility which might be unfortunate for day traders caught on the wrong side.