The stock market is inherently volatile, and sudden price swings can result in significant losses for investors. To mitigate these risks, the Securities and Exchange Board of India (SEBI) introduced the concept of "circuits" to regulate price fluctuations within a single trading day. These circuits include an upper circuit and a lower circuit, which cap the maximum and minimum price a stock can achieve during a trading session.
- The upper circuit represents the highest price a stock can reach, triggered by excessive buy pressure.
- The lower circuit is the lowest price a stock can hit, usually caused by overwhelming sell pressure with limited buyers.
These thresholds are calculated based on the previous day's closing price and can vary between stocks. They act as a safeguard to protect investors from extreme volatility.
What is upper circuit and how it works?
In the stock market, the upper circuit represents the maximum price limit that a stock can achieve within a trading session. This limit is established by stock exchanges to mitigate excessive volatility and to safeguard investors from erratic price surges. When a stock reaches its upper circuit, trading is temporarily halted to prevent further upward movement in its price. This usually happens when there is an overwhelming demand for the stock, with more buyers than sellers, driving the price up rapidly. Understanding the upper circuit is essential for investors, as it helps them gauge market sentiment and make informed decisions during periods of high buying activity.
What is lower circuit and how it works?
The lower circuit is the minimum price level that a stock can fall to during a trading session. When a stock hits this limit, trading is temporarily paused to avoid further declines in its price. This mechanism is crucial for maintaining market stability, especially during periods of heightened selling pressure. A stock hitting its lower circuit typically indicates a surplus of sellers compared to buyers, leading to a sharp drop in price. Understanding the lower circuit helps investors navigate volatile market conditions by signalling the extent of potential price depreciation in a stock.
What are the upper and lower circuits for stocks?
Now that you have seen what the upper and lower circuits in the share market are, let us look at the limits that the exchanges have set for stocks.
Stocks that are categorised by the exchanges under groups A, B, T, and TS have upper and lower circuit limits ranging from 2% to 5%. Stocks featured in the above-mentioned groups are actively traded on the stock exchanges.
Stocks that are categorised by the exchange under group S have higher upper circuit and lower circuit limits ranging from 10% to 20%. These stocks are more susceptible to speculative trading.
Here is an example to help you understand how circuit limits are arrived at for a stock.
Assuming a stock has a circuit limit of 10% and its previous day’s closing price was Rs. 2,000, the upper circuit limit of the stock for the current trading session would be Rs. 2,200 [Rs. 2,000 + (Rs. 2,000 * 10%)]. The lower circuit limit, on the other hand, for the stock would be Rs. 1,800 [Rs. 2,000 - (Rs. 2,000 * 10%)]. The circuit limits are changed every day according to the previous day’s closing price.
Also read: What is technical analysis?
What are the upper and lower circuits for market indices?
Unlike stocks, which generally have a single fixed limit, there are three upper circuit and lower circuit limits for market indices.
- First circuit limit: 10% of the previous day’s closing price
- Second circuit limit: 15% of the previous day’s closing price
- Third circuit limit: 20% of the previous day’s closing price
Each time a circuit limit is breached, trading is temporarily halted anywhere from 15 minutes to the rest of the trading session, depending on the time of day.
Ways to use circuits on company stocks
Investors can use the knowledge of upper and lower circuits to make informed decisions and safeguard their investments:
- Using stop-loss orders:
Set stop-loss orders to sell a stock if it nears the lower circuit. This automated feature helps minimise losses by selling the stock before its price declines further. - Monitoring the circuits:
Regularly track the upper and lower circuits of stocks of interest. Understanding a stock’s volatility helps in making calculated investment decisions. - Avoid herd mentality:
Avoid blindly following trends. A stock hitting its upper circuit doesn’t guarantee continued growth, and a lower circuit does not always signal a poor investment. - Conduct proper research:
Perform thorough research before investing. Analyse factors like earnings, debt levels, PE ratios, industry comparisons, and news to understand the reasons behind price movements. - Benefit from opportunities:
Use circuits to your advantage. For example, a stock hitting its lower circuit may present a buying opportunity, while an upper circuit could be an ideal time to sell and book profits.
What drives the upper/lower circuit?
The interplay of demand and supply primarily drives a stock or index to its upper or lower circuit. Several additional factors influence this dynamic:
- Mergers and acquisitions:
Mergers often increase investor optimism, boosting demand for the stock. Conversely, acquisitions that add financial strain can reduce demand. - Political disturbances:
Political unrest or instability decreases investor confidence, leading to reduced stock prices. In contrast, stable governance and favourable policies often drive prices upward. - Changes in trade agreements:
Positive trade agreements can increase demand for stocks of benefiting companies, while unfavourable terms can have the opposite effect. - Interest rate fluctuations:
Rising interest rates typically reduce investment and stock prices, while lower rates encourage investment, driving prices higher. - Financial performance of a company:
Strong financial results attract investors and boost demand, while weak performance discourages investments, lowering demand and prices. - Expansions, insolvencies, and consolidations:
Announcements of business expansions often raise investor expectations and demand, while insolvencies or consolidations decrease demand due to anticipated financial struggles. - Investor confidence:
Positive news about a company or market index fuels investor confidence and stock prices. Conversely, negative news reduces confidence, leading to price declines.
By understanding these factors, investors can navigate market volatility and make informed decisions.
What is the primary driving factor of upper and lower circuits?
The upper and lower circuit limits are set based on the asset’s previous closing price. This essentially means that if there is a change in the previous day’s closing price, the upper circuit and lower circuit limits will also change accordingly.
1. Organizational Structure Changes
- Mergers and Acquisitions: Positive market perception often leads to increased demand for stocks post-merger. Conversely, acquisitions can strain finances, potentially decreasing demand.
- Expansions, Insolvencies, and Consolidations: Growth announcements boost demand, while financial difficulties dampen it.
2. External Factors
- Political Instability: Unrest can erode investor confidence, causing stock prices to fall.
- Trade Agreements: Favorable agreements can increase demand for benefiting companies, while unfavorable ones can decrease it.
- Interest Rates: Higher rates can reduce investment, lowering stock prices. Lower rates can stimulate investment, raising stock prices.
3. Company Performance
Strong performance attracts investors, increasing demand. Weak performance can deter investors, decreasing demand.
4. Investor Sentiment:
Positive news or sentiment can boost demand, while negative factors can decrease it.
These factors collectively influence the demand and supply of stocks, ultimately affecting their prices and triggering the activation of upper and lower circuits.
Essential facts on upper circuit and lower circuit limits you need to know
Knowledge of upper and lower circuits is crucial since it influences your trading strategies, risk management and decision-making processes. Here are some key facts that you need to know about these limits.
- The circuits act as safety mechanisms safeguarding investors' interests, preventing panic selling, or buying during periods of extreme market volatility.
- The upper circuits and lower circuits limits for stocks and indices are published and routinely updated before a trading session on the websites of stock exchanges.
- If a stock hits its upper circuit, you cannot purchase any shares since there will not be any sellers. In the case of a stock that hits its lower circuit, you cannot sell any shares since there will not be any buyers.
- If trading is suspended for the rest of the day due to a circuit limit breach, all intraday orders are automatically converted into delivery orders by the broker.
Once set, circuit limits do not remain static. Instead, they are adjusted periodically based on factors like market conditions, trading volumes and volatility levels.
Conclusion
With this, you must now be aware of what the upper and lower circuits in the share market are. These safeguards play a crucial role in maintaining order and stability in the market by curbing excessive volatility. Remember, the upper and lower circuits may vary from time to time. As an investor, it is important to consider them before placing any trades since they can have a major impact on your trading strategies and risk management practices.
