Circuit Breaker

History

The circuit breaker was first introduced to prevent a market collapse after the crash of 19 October 1987, known as Black Monday. US President Ronald Reagan assembled a Task Force on Market Mechanisms (the Brady Commission), whose report held that whichever regulatory agency monitored equity markets should design and implement price-limit systems known as circuit breakers. The original intent was not to prevent dramatic but fair price swings, but to allow time for sufficient communication between traders and specialists. The New York Stock Exchange rules were put in place beginning January 1988, weeks after Black Monday.

The regulatory filing making circuit breakers mandatory on US stock exchanges is SEC Rule 80B; its most recent amendment took effect on 8 April 2013. Each day the NYSE sets Level 1 at 7%, Level 2 at 13% and Level 3 at 20%, measured as percentage declines in the S&P 500 against the previous trading day's close. Levels 1 and 2 each cause a halt of at least 15 minutes (no halt after 3:25 p.m.) and apply at most once per level per day, while a Level 3 decline halts trading for the remainder of the day. Since 1997 the system evolved from a Dow Jones Industrial Average points-based system into a percentage-change system tracking the S&P 500.

In the Republic of Korea the circuit breaker was introduced on 7 December 1998, when the daily price limit was widened to ±15%. It triggers when the KOSPI or KOSDAQ index falls 8% or more against the previous close for at least one minute, suspending all orders in spot stocks as well as futures and options for 20 minutes, followed by 10 minutes of simultaneous-quote trading before resumption. In June 2015, as the price limit widened to ±30%, the system was subdivided into three tiers: Level 1 on an 8% or greater fall (20-minute halt, then 10 minutes of single-price trading), Level 2 on a 15% or greater fall (same protocol), and Level 3 on a 20% or greater fall, which ends the day's trading early. It does not trigger within 40 minutes of the close, and each level applies only once a day.

Distinctions

The circuit breaker is a stronger measure than the sidecar: it halts stock trading itself to prevent a further plunge, whereas the sidecar blocks futures shocks before they reach the spot market and is preventive in character. The circuit breaker is described as the 'last resort' for market stabilization. When the sidecar triggers, quote validity in the stock market stops for 5 minutes; the conditions are the most-traded futures product moving 5% or more (KOSPI) or 6% or more (KOSDAQ) against the previous close for at least one minute.

Separate from the market-wide circuit breaker, there are mechanisms aimed at security-specific rather than market-wide volatility. In the United States the Limit Up–Limit Down (LULD) plan sets a 10% change for securities in the S&P 500, Russell 1000 and Invesco QQQ, 30% for any security priced at or above $1, and 50% for any security priced under $1, each occurring within a 5-minute window, with the price band determined by the previous day's close. In Japan stock trading is halted for 10 minutes when the criteria are met, and the Philippine Stock Exchange adopted a mechanism in September 2008 allowing a 15-minute halt on a 10% fall. In China a mechanism began a test run on 1 January 2016; it was fully triggered on 4 and 7 January and its use was suspended from 8 January 2016.

Examples

On 27 October 1997, under the trading-curb rules then in effect, trading on the New York Stock Exchange was halted early after the Dow Jones Industrial Average declined by 550 points, the first time US stock markets closed early under trading curbs. Then-SEC Chairman Arthur Levitt Jr. considered the use unnecessary because, in percentage terms, the decline was not a crisis. In March 2020 the Level-1 breaker was triggered four times in one month on COVID-19 and oil-price fears (9, 12, 16 and 18 March).

The 6 May 2010 flash crash lasted about 36 minutes, with the Dow plunging 998.5 points (about 9%) intraday. After it, security-specific curbs were tested, beginning with 5 stocks on 11 June 2010 and reaching all 404 NYSE-listed S&P 500 companies by 16 June 2010.

In Korea, at about 11:55 a.m. on 12 February 2016 the KOSDAQ index fell more than 8% and the circuit breaker was triggered, the seventh time in history and the first since 8–9 August 2011, four years and six months earlier. On 13 March 2020 circuit breakers and sidecars were triggered together on the KOSDAQ and KOSPI.

Issues

Although the purpose is to give traders time to digest new information, empirical work reports that trading volume increases as price approaches a threshold and that trading after a halt can lay the groundwork for more volatile conditions. The 'magnet effect' thesis, developed by Michael A. Goldstein and Kenneth A. Kavajecz in a 2004 article in the Journal of Financial Markets, holds that the closer market levels come to a threshold, the more traders increase volume by unloading shares out of fear of being stuck in their positions. This is an academic thesis rather than an established finding.

Halts also reduce the flow of information by removing market activity, which can cause larger-than-normal bid-ask spreads that slow the price-discovery process. The NYSE scrapped its separate program-trading curb from 2 November 2007, citing its ineffectiveness in curbing market volatility. Disputes over the causes of the 2010 flash crash and over early-warning measures such as VPIN also remain unresolved. Futures-market safeguards and circuit breakers interact: during the flash crash the CME's Stop Logic Functionality paused E-Mini S&P futures trading for five seconds at 2:45:28 p.m., after which prices stabilized.