How Do Stock Market Circuit Breakers Work?
Trading halts are designed to give investors a chance to breathe when things get ugly. Here's how they function.
U.S. stocks had gone more than 20 years without a market-wide trading halt. We've now tripped the so-called circuit breakers two times in four days.
On Monday, March 9, the S&P 500 fell 7% within minutes of the open, triggering a market-wide trading halt for the first time since 1997. Thursday morning's plunge of more than 7% also tripped a circuit breaker.
Circuit breakers were first introduced after the Black Monday crash of October 1987. The Dow dropped almost 23% in a single session, which stands as a record to this day.
Circuit breakers are intended to curb panic selling. Like calling a timeout in sports, a temporary pause in trading allows market participants to catch their breath, though it doesn't necessarily keep stocks from declining once trading resumes.
How Circuit Breakers Work
There are three levels of circuit breakers tied to how steeply the market declines:
- A Level 1 market-wide circuit breaker is tripped if the S&P 500 falls 7% from its previous close.
- A Level 2 circuit breaker comes into effect when the market plunges 13%.
- A Level 3 circuit breaker kicks in if the market tanks 20%.
A Level 1 or Level 2 breach halts trading for a minimum of 15 minutes. A Level 3 rout halts trading for the remainder of the trading day.
Level 1 and Level 2 circuit breakers can be triggered between 9:30 a.m. and 3:25 p.m. Eastern. A Level 3 breach can be triggered at any time.
Individual stocks also have circuit breakers, with the trigger levels determined by the price of the stock.
The circuit breakers have worked as intended this week, in that they've given traders a chance to at least catch up as markets tumble on the growing COVID-19 pandemic. Given that the outcome of this crisis is impossible to price in at this point, don't be shocked if we trip circuit breakers repeatedly in the sessions ahead.