Circuit Breakers Explained: How Trading Halts Protect Markets

During the March 2020 COVID crash, stock markets triggered circuit breakers multiple times, halting trading to prevent panic selling from spiraling out of control. These automatic safeguards are designed to give investors time to assess information and make rational decisions during extreme market stress.

What Are Circuit Breakers?

Circuit breakers are automatic mechanisms that temporarily halt trading when prices fall too quickly. They were implemented after the 1987 Black Monday crash when the Dow Jones dropped 22.6% in a single day. The goal is to pause trading during extreme volatility, allowing investors to process information and preventing panic-driven cascades.

Market-Wide Circuit Breaker Levels

The S&P 500 index serves as the reference point for market-wide circuit breakers. There are three levels based on the percentage decline from the previous day's close:

Level 1: 7% Decline

• Triggers a 15-minute trading halt
• Only triggers once per day
• Only applies if triggered before 3:25 PM ET
• If triggered after 3:25 PM, trading continues until close

Level 2: 13% Decline

• Triggers another 15-minute trading halt
• Only triggers once per day
• Only applies if triggered before 3:25 PM ET
• If triggered after 3:25 PM, trading continues until close

Level 3: 20% Decline

• Triggers a halt for the remainder of the trading day
• Can trigger at any time
• This is the most severe circuit breaker

Individual Stock Halts: LULD

Beyond market-wide breakers, individual stocks can be halted through the Limit Up-Limit Down (LULD) mechanism. This prevents extreme price swings in individual securities.

How LULD Works

• Price bands are set around the average price over the previous 5 minutes
• If a stock hits the upper or lower band, it enters a 15-second pause
• If trading cannot resume within the bands, a 5-minute halt occurs
• Band widths vary based on stock price and market cap

LULD Band Widths

• Tier 1 (S&P 500, Russell 1000): 5% bands for stocks over $3
• Tier 2 (other NMS stocks): 10% bands for stocks over $3
• Low-priced stocks (under $3): Wider percentage bands apply
• Opening and closing periods: Doubled band widths

Other Types of Trading Halts

Besides volatility-triggered halts, trading can stop for other reasons:

News Pending Halts (T1)

A company can request a trading halt to release material news. This ensures all investors receive important information simultaneously. Common triggers include earnings announcements, merger news, or FDA decisions for biotech companies.

Regulatory Halts

The SEC can halt trading if there are concerns about market manipulation, inadequate disclosure, or other regulatory issues. These halts can last for days or even weeks.

Technical Halts

Exchanges can halt trading due to technical issues like connectivity problems, data feed errors, or system malfunctions. These are typically resolved quickly.

Trading Around Circuit Breakers

Circuit breakers create both risks and opportunities for traders:

Risks During Halts

• Cannot exit positions: You are locked in during the halt
• Gap risk: Prices can move significantly when trading resumes
• Stop orders may not execute: Stops cannot trigger during halts
• Options complexity: Options pricing becomes uncertain

Strategies for Extreme Volatility

• Reduce position sizes: Smaller positions mean less exposure to gap risk
• Use options for protection: Puts remain valuable even if you cannot sell shares
• Avoid market orders: Use limit orders when trading resumes
• Stay informed: Monitor news during halts to prepare for reopening

How Circuit Breakers Have Evolved

Circuit breaker rules have changed significantly since their introduction:

Original Rules (1988-2012)

After Black Monday, circuit breakers were based on the Dow Jones Industrial Average with fixed point triggers. These point-based triggers became less relevant as markets grew.

Current Rules (2013-Present)

After the 2010 Flash Crash, rules were updated to use percentage-based triggers on the S&P 500. The LULD mechanism was added for individual stocks. These percentage-based rules scale automatically with market levels.

International Circuit Breakers

Other major markets have similar mechanisms:

• China: 5% and 7% circuit breakers (though the 7% trigger was suspended after causing panic)
• Japan: Dynamic circuit breakers based on price levels
• Europe: Individual exchange rules with volatility interruptions
• India: 10%, 15%, and 20% market-wide triggers

Criticism and Debate

Circuit breakers remain controversial among market participants:

Arguments For Circuit Breakers

• Prevent panic selling and irrational cascades
• Give investors time to process information
• Reduce the impact of algorithm-driven crashes
• Maintain orderly markets during extreme stress

Arguments Against Circuit Breakers

• Can accelerate selling as investors rush to exit before halts
• Interfere with price discovery
• Create uncertainty about when trading will resume
• May not prevent ultimate losses, just delay them

Summary

Circuit breakers are automatic trading halts designed to prevent market crashes from spiraling out of control. Market-wide breakers trigger at 7%, 13%, and 20% declines in the S&P 500, while individual stocks can be halted through the LULD mechanism. Understanding how these safeguards work helps you prepare for extreme volatility and make better decisions during market stress.

Want to learn more about market structure? Read about black swan events or explore strategies for volatile markets.