What are circuit filters, and how do they protect investors?

What are circuit filters, and how do they protect investors?

Circuit filters, also known as circuit breakers, are safety nets (regulatory mechanisms) in the stock market, which are designed to control extreme price swings in a single trading session.
They are regulated by SEBI and enforced by NSE and BSE. These mechanisms help curb excessive volatility.

They do this by setting price bands for individual stocks (2%, 5%, 10%, or 20%) and triggering haults/pauses in trading for indices when they hit 10%, 15%, or 20% movement thresholds. This prevents panic-driven crashes, keeps speculation in check, and ensures a more stable trading environment.

The implementation of circuit limits is done by the stock exchanges primarily the NSE (National Stock Exchange) and BSE (Bombay Stock Exchange) based on guidelines prescribed by SEBI.

Stock exchanges assign circuit limits based on the following:
  1. Stock's Liquidity: Less liquid (thinly traded) stocks are more volatile, so tighter limits (like 2% or 5%) are used.
  2. Market Capitalization: Smaller companies usually have lower circuit limits, while large-cap stocks may have wider limits or no limits (in some cases).
  3. Historical Volatility: If a stock has a history of sharp price movements, a tighter circuit limit is imposed to prevent manipulation.
  4. Trading Category: Stocks under surveillance measures (ASM/GSM) or subject to regulatory monitoring often have stricter limits.

How Do Circuit Breakers Protect Investors?

Circuit breakers protect investors in multiple ways, some of which are mentioned below:
  1. Preventing Panic-Driven Selling and Buying: Circuit breakers pause trading during extreme/volatile market movements, allowing investors to make rational decisions.
  2. Reduced Market Manipulation: They stop sudden, artificial price swings caused by excessive speculation or unfair trading practices.
  3. Boost Investor Confidence: By reducing extreme volatility, they create a safer and more predictable market environment for investors.
  4. Allow Time for Market Stability: The temporary hault helps the market absorb news and adjust prices gradually rather than through sudden crashes or spikes in rates.
  5. Ensure Fair Trading: Circuit filters make sure stock prices reflect real market trends instead of short-term speculation or panic reactions.

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