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A trading curb (typically known as a circuit breaker in
Wall Street Wall Street is an eight-block-long street in the Financial District of Lower Manhattan in New York City. It runs between Broadway in the west to South Street and the East River in the east. The term "Wall Street" has become a metonym for t ...
parlance) is a financial regulatory instrument that is in place to prevent
stock market crash A stock market crash is a sudden dramatic decline of stock prices across a major cross-section of a stock market, resulting in a significant loss of paper wealth. Crashes are driven by panic selling and underlying economic factors. They often f ...
es from occurring, and is implemented by the relevant
stock exchange A stock exchange, securities exchange, or bourse is an exchange where stockbrokers and traders can buy and sell securities, such as shares of stock, bonds and other financial instruments. Stock exchanges may also provide facilities for the ...
organization. Since their inception, circuit breakers have been modified to prevent both speculative gains and dramatic losses within a small time frame. When triggered, circuit breakers either stop trading for a small amount of time or close trading early in order to allow accurate information to flow among market makers and for institutional traders to assess their positions and make rational decisions.


United States


Description

On the
New York Stock Exchange The New York Stock Exchange (NYSE, nicknamed "The Big Board") is an American stock exchange in the Financial District of Lower Manhattan in New York City. It is by far the world's largest stock exchange by market capitalization of its listed co ...
(NYSE), one type of trading curb is referred to as a "circuit breaker". These limits were put in place beginning in January 1988 (weeks after Black Monday occurred in 1987) in order to reduce market volatility and massive panic sell-offs, giving traders time to reconsider their transactions. The regulatory filing that makes circuit breakers mandatory on United States stock exchanges is
Securities and Exchange Commission The U.S. Securities and Exchange Commission (SEC) is an independent agencies of the United States government, independent agency of the United States federal government, created in the aftermath of the Wall Street Crash of 1929. The primary pu ...
Rule 80B.NYSE Market Guide. Trading Halts Due to Extraordinary Market Volatility. Rule 80B. Chicago, IL: Wolters Kluwer Financial Services, 2012. It is there that the specifics of circuit breakers are elaborated and the various price limits are outlined for investors to see. The most recently updated amendment of rule 80B went into effect on April 8, 2013, and has three tiers of thresholds that have different protocols for halting trading and closing the markets. At the start of each day, the NYSE sets three circuit breaker levels at levels of 7% (Level 1), 13% (Level 2) and 20% (Level 3). These thresholds are the percentage drops in value that the
S&P 500 Index The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices. As of ...
would have to suffer in order for a trading halt to occur. Base price levels for which these thresholds will be applied are calculated daily based on the preceding trading day's closing value of the S&P 500. Depending on the point drop that happens and the time of day when it happens, different actions occur automatically: Level 1 and Level 2 declines result in a 15-minute trading halt unless they occur after 3:25pm, when no trading halts apply. A Level 3 decline results in trading being suspended for the remainder of the day. Circuit breakers are also in effect on the
Chicago Mercantile Exchange The Chicago Mercantile Exchange (CME) (often called "the Chicago Merc", or "the Merc") is a global derivatives marketplace based in Chicago and located at 20 S. Wacker Drive. The CME was founded in 1898 as the Chicago Butter and Egg Board, an a ...
(CME) and all subsidiary exchanges where the same thresholds that the NYSE has are applied to equity index futures trading. However, there is a CME specific price limit that prevents 5% increases and decreases in price during after hours trading. Base prices for which the percentage thresholds are applied are derived from the weighted average price on the future during the preceding trading day's last thirty seconds of trading. Price limits for equity index and foreign exchange futures are posted on the CME website at the close of each trading session. There is a security specific circuit breaker system, similar to the market wide system, that is known as the "Limit Up - Limit Down Plan" (LULD). This LULD system succeeds the previous system that only prevented dramatic losses, but not speculative gains, in a short amount of time. This rule is in place to combat security specific volatility as opposed to market wide volatility. The thresholds for a trading halt on an individual security are as follows. Each percentage change in value has to occur within a 5-minute window in order for a trading halt to be enacted: * 10% change in value of any security that is included in the S&P 500 index, the Russell 1000 index, and the
Invesco PowerShares Invesco PowerShares (formerly PowerShares Capital Management) is an American boutique investment management firm based near Chicago which manages a family of exchange-traded funds or ETFs. The company has been part of Invesco, which markets the ...
QQQ ETF. * 30% change in value of any security that has a price equal to or greater than $1 * 50% change in value of any security that has a price less than $1 The previous trading day's closing price is used to determine which price range a specific security falls into.


Founding

Following the stock market crash on October 19, 1987, the United States President Ronald Reagan assembled a Task Force on Market Mechanisms, known as the Brady Commission, to investigate the causes of the crash. The Brady Commission's report had four main findings, one of which stated that whatever regulatory agency was chosen to monitor equity markets should be responsible for designing and implementing price limit systems known as circuit breakers. The original intent of circuit breakers was not to prevent dramatic but fair price swings, rather to allow time for sufficient communication between traders and specialists. In the days leading up to the crash, price swings were dramatic but not crisis-like. However, on Black Monday the crash was caused by lack of information flow through the markets among other discrepancies such as lack of uniform margin trading rules across different markets.


Instances of use

On October 27, 1997, under the trading curb rules then in effect, trading at the New York Stock Exchange was halted early after the Dow Jones Industrial Average declined by 550 points. This was the first time US stock markets had closed early due to trading curbs. Since then, circuit breakers have evolved from a
Dow Jones Industrial Average The Dow Jones Industrial Average (DJIA), Dow Jones, or simply the Dow (), is a stock market index of 30 prominent companies listed on stock exchanges in the United States. The DJIA is one of the oldest and most commonly followed equity indexe ...
points-based system into a percentage change system that tracks the S&P 500. Then SEC Chairman Arthur Levitt Jr. believes this use was unnecessary, and that market price levels had increased so much since circuit breakers were implemented that the point based system triggered a halt for a decline that was not considered a crisis. Some, like Robert R. Glauber, suggested in the aftermath of the circuit breaker tripping that trigger points be increased, and automatically reset by formula on an annual basis. On March 9, 2020, the Dow Jones fell by 7.79% (2,013 points) on fears of the COVID-19 coronavirus and falling oil prices, and the S&P 500 triggered a market shutdown for 15 minutes just moments after opening. Three days later on March 12 and again on March 16 early trading again tripped the level-1 circuit breaker when the markets dropped over 7%. On March 18 the breaker was triggered again at one in the afternoon, several hours after trading opened.


Program trading curbs

The NYSE formerly implemented a curb on
program trading Program trading is a type of trading in securities, usually consisting of baskets of fifteen stocks or more that are executed by a computer program simultaneously based on predetermined conditions. Program trading is often used by hedge funds an ...
under certain conditions. A program trade is defined by the NYSE as a basket of stocks from the S&P 500 where there are at least 15 stocks or where the value of the basket is at least $1 million. Such trades are generally automated. When activated, the curbs restricted program trades to sell on upticks and buy only on downticks. The trading curbs would become activated whenever the
NYSE Composite Index The NYSE Composite (^NYA) is a stock market index covering all common stock listed on the New York Stock Exchange, including American depositary receipts, real estate investment trusts, tracking stocks, and foreign listings. It includes corporatio ...
moved 190 points or the Dow Jones Industrial Average moved 2% from its previous close. They remained in place for the rest of the trading day or until the NYSE Composite Index moved to within 90 points or the Dow moved within 1% of the previous close. Since over 50% of all trades on the NYSE are program trades, this curb was supposed to limit volatility by mitigating the ability of automated trades to drive stock prices down via
positive feedback Positive feedback (exacerbating feedback, self-reinforcing feedback) is a process that occurs in a feedback loop which exacerbates the effects of a small disturbance. That is, the effects of a perturbation on a system include an increase in the ...
. This curb was fairly common, and financial television networks such as CNBC often referred to it with the term "curbs in". On November 7, 2007, the NYSE confirmed that the exchange has scrapped this rule from November 2, 2007. The reason given for the rule's elimination was its ineffectiveness in its purpose of curbing market volatility since it was enacted in the wake of the 1987 stock market crash under the belief that it may help prevent another catastrophic market crash.


Japan

In Japan, stock trading will be halted in cases where the criteria for the circuit breaker trigger are met. The trading halt time is 10 minutes.


China

A "circuit-breaker" mechanism began a test run on January 1, 2016. If the
CSI 300 Index The CSI 300 () is a capitalization-weighted stock market index designed to replicate the performance of the top 300 stocks traded on the Shanghai Stock Exchange and the Shenzhen Stock Exchange. It has two sub-indexes: the CSI 100 Index and the C ...
rises or falls by 5% before 14:45 (15 minutes before normal closing), stock trading will halt for 15 minutes. If it happens after 14:45 or the Index change reaches 7% at any time, trading will close immediately for the day. "Full breaking" was triggered on January 4 and 7, 2016. From January 8, use of the circuit-breaker was suspended.


Philippines

The
Philippine Stock Exchange The Philippine Stock Exchange, Inc. ( fil, Pamilihang Sapi ng Pilipinas; ) is the national stock exchange of the Philippines. The exchange was created in 1992 from the merger of the Manila Stock Exchange and the Makati Stock Exchange. Includin ...
(PSE) adopted a circuit breaker mechanism in September 2008. Under the mechanism stock trading may be halted for 15 minutes if the (PSE) falls at least 10% based on the previous day's closing index value. Trading may be halted only once per market session and not 30 minutes prior to noon or the trade closing. Trading has been halted only twice. The first Time was on October 27, 2008 during a
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that saw the PSE index falling 10.33%, and the second time was on March 12, 2020 as a result of the uncertainty caused by the coronavirus pandemic.


Effectiveness

Though the purpose behind circuit breakers is to stop trading so that traders can take time to think and digest new information, there are a lot of tested theories that show trading volume actually increases as price levels approach a circuit breaker threshold, and trading after a halt completes lays the groundwork for even more volatile market conditions.


Magnet effect

The ''Journal of Financial Markets'' has published work specific to the use of circuit breakers and their effects on market activity. Researchers have developed what is known as the "magnet effect". This theory claims that the closer market levels come to a circuit breaker threshold, the more exacerbated the situation will become as traders will increase volume by unloading shares out of fear that they will be stuck in their positions if markets do stop trading.Michael A. Goldstein, Kenneth A. Kavajecz, "Trading Strategies During Circuit Breakers and Extreme Market Movements", ''Journal of Financial Markets'', volume 7, issue 3, June 2004, pages 301-333 It is believed there was an institutional bias to circuit breakers, as all of the large banks,
hedge fund A hedge fund is a pooled investment fund that trades in relatively liquid assets and is able to make extensive use of more complex trading, portfolio-construction, and risk management techniques in an attempt to improve performance, such as shor ...
s, and even some pension funds had designated floor traders on the floor of the NYSE who can continue trading while the markets are closed to the average investor. This argument is becoming less relevant over time as the use of floor traders diminishes and the majority of trading is done by computer generated algorithms.


Price discovery

Price discovery In economics and finance, the price discovery process (also called price discovery mechanism) is the process of determining the price of an asset in the marketplace through the interactions of buyers and sellers. Overview Price discovery is dif ...
as it relates to equities is the process in which a security's market value is determined by way of buyers and sellers agreeing on a price suitable enough for a transaction to take place. On the New York Stock Exchange alone, it is not uncommon for over $1.5 trillion of stocks to be traded in a single day. Due to the large amount of transactions that take place every day, experienced traders, and computer using
algorithmic trading Algorithmic trading is a method of executing orders using automated pre-programmed trading instructions accounting for variables such as time, price, and volume. This type of trading attempts to leverage the speed and computational resources of ...
make trades based on the slightest up-ticks and down-ticks in price, and subtle changes in the
bid–ask spread The bid–ask spread (also bid–offer or bid/ask and buy/sell in the case of a market maker) is the difference between the prices quoted (either by a single market maker or in a limit order book) for an immediate sale (ask) and an immediate pur ...
.Lee, Charles M. C., Mark J. Ready, and Paul J. Seguin. "Volume, Volatility, And New York Stock Exchange Trading Halts". ''Journal of Finance'' 49.1 (1994): 183-214. When trading halts for any amount of time, the flow of information is reduced due to a lack of market activity, adversely causing larger than normal bid-ask spreads that slows down the price discovery process. When stock specific trading halts occur in order for press releases to be announced, the market has to then make a very quick assessment of how the new information affects the value of the underlying asset leading to abnormal trading volume and volatility.


See also

*
Stock market crash A stock market crash is a sudden dramatic decline of stock prices across a major cross-section of a stock market, resulting in a significant loss of paper wealth. Crashes are driven by panic selling and underlying economic factors. They often f ...
* Trading halt * 2010 Flash Crash, after which the SEC announced a trial period of per-stock trading curbs


References

{{reflist, 2


External links


Circuit Breakers and Other Market Volatility Procedures
at the New York Stock Exchange

at the Chicago Board of Trade Share trading