Circuit Limit

What is Upper Circuit and Lower Circuit in share market?

The Circuit Limit in stock market refers to the maximum and minimum price, at which a financial security can trade on any given day. These are usually calculated and notified by the Stock Exchange, at the start of a trading day.

The idea of specifying the trading price limits will become more important when the prices of the security are moving rapidly in a day. Pre-defining a highest and lowest price will help in preventing a large and quick increase/decrease in the market price of securities.

Usually, it is the responsibility of the Stock Broker to block the traders from placing an order at a price, that is beyond the defined price limits. Also, if the trading price of the security touches these limits, then some emergency actions get automatically triggered (also known as Circuit Breakers).

Need for Circuit Limit

For any financial security, the supply and demand in the market will govern the movement in the price. In some situations, the price could rapidly move in one direction, when sufficient counter-parties are not available. For example, a negative news about the company might break out, which could lead to a sudden jump in the number of sell orders.

A rapid change in the price of the security could influence even more market participants to react, and make rash trading decisions. On the other hand, the passive and inactive traders/investors might get late in learning about the market developments related to the price.

So, to protect all the market participants, the Circuit Limits will be used to communicate a price band, in which the security could trade on a given day. This restricts the maximum and minimum profit/loss that could be realized due to price movement.

In addition, the Circuit in stock market also prevents a sudden spread of panic or euphoria in the market, because it gives some time to the market participants to reconsider their buy or sell decisions.

Defining the Circuit Limit

Since this is a price range, there are 2 parts that need to be defined in the Circuit Limits. The Upper Circuit refers to the highest price at which a security is allowed to trade on any given day. Whereas the Lower Circuit refers to the lowest price at which the trade could happen in the day.

The Circuit Limit on Stock Market is usually communicated in percentage terms, and it is calculated from the previous Closing Price of the security. To get a price band, it is measured in both the upward and downward direction from the previous Close Price. The price trigger limits that are most commonly used are: 2%, 5%, 10%, 15% and 20%.

The Circuit Limits are daily calculated and notified for each financial security that is trading on the Stock Exchange. These limits could be different, based on the factors like: type of security, volatility, liquidity, whether the stock also trades in Equity F&O segment, trade restrictions etc.

The same concept can also be applied at the market level, by measuring the Circuit Price Limit for the Benchmark Index (NIFTY, SENSEX, S&P 500 etc.). If there is a big movement in the price of the Benchmark, then the Market Wide Circuit Breakers (MWCBs) get triggered. Usually, this includes a temporary suspension in trading of all the financial securities in the market.

Calculating Circuit Limit

Let us use a simple example to explain what is Circuit Limit and how is it calculated. Suppose that the previous Closing Price for a particular stock was INR 24.65, and the upper and lower circuit for this stock is set at +/- 5%. So, the price difference in this case will become:

5% of INR 24.65 = INR 1.2325

As mentioned below, this price difference can be used to measure Upper Circuit.

INR 24.65 + INR 1.2325 = INR 25.8825

But due to the restrictions on Tick Size, INR 25.8825 might not be a valid trading price. So, the Upper Circuit price will have to be rounded-down to INR 25.85 (assuming a Tick Size of INR 0.05). If the Tick Size was INR 0.01, then the Upper Circuit would have been INR 25.88. This means that the actual Upper Circuit that is applied in percentage terms will be:

(25.85 − 24.65) / 24.65 = 0.0487 or 4.87%

Lower Circuit

Similarly, the Lower Circuit for this stock can be calculated by subtracting the price difference from the previous Close Price.

INR 24.65 − INR 1.2325 = INR 23.4175

But INR 23.4175 might not be a valid trading price, because of the restrictions on the Tick Size. So, the Lower Circuit price will have to be rounded-up to INR 23.45 (assuming a Tick Size of INR 0.05). The Lower Circuit would have been INR 23.42, if the Tick Size was INR 0.01.

So, based on the Closing Price used in this example, the Stock Circuit Limit will become: INR 23.40 to INR 25.85 (when Tick Size is INR 0.05).

Note: It is worth mentioning that we would always need to round-down the calculated Upper Circuit value. And we would need to round-up the calculated Lower Circuit value. This is because if we had used INR 25.90 and INR 23.40, then the actual circuit that is applied will be greater than +/- 5%. But setting a Share Circuit Limit above the defined percentage is not allowed (5% in this example).

After hitting Circuit Limits

When the price of Benchmark Index touches the defined Circuit Limit, then a Market Wide Circuit Breaker (MWCB) is triggered, and trading is temporarily stopped for all the securities. Depending on the time at which the Circuit Breaker was hit, the trading might or might not resume on that day. This brief halt in trading is also known as Cooling Period.

Besides the index, the daily price bands in stock market are also defined for individual securities. If a Circuit Limit is touched for a security and counter-parties are not available, then the orders will remain pending at the Circuit Price. In such a case, one of the below-mentioned situations might happen:

Case 1: Limits could be relaxed. For example, let us assume that the previous Close Price for a stock was INR 100, and the Upper Circuit was set at INR 105 (5%). Suppose that the market price hits INR 105, and the buy orders remain pending because no sellers are available at INR 105 (or below). So, after some time, the Stock Exchange could change the Upper Circuit for that day to INR 110 (10%), for instance. This change in the price limits is also known as Flexing.

Case 2: Same limits are kept. In some cases, the Circuit in share market cannot be changed due to trade restrictions on the security, or because the maximum possible circuit is already hit. So, the trading will continue at the same limits.

For example, suppose that the previous Close Price for a stock was INR 300, and the Lower Circuit is set at the maximum possible value of INR 240 (20%). If the market price touches INR 240 and no sellers are available, then the buy orders will remain pending at this price. The trades will get executed only when new buy orders are placed at INR 240 (or above).

For more details about how circuits work in India, Refer: What happens when Stock hits Circuit Breaker?

Disclaimer

  • This page is for education purpose only
  • Some information could be outdated / inaccurate
  • Investors should always consult with certified advisors and experts before taking final decision
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