What does Upper Circuit mean in stock markets?
Imagine XYZ, a pharmaceutical company, finds the cure to cancer. What would happen to its stock price? Naturally, people would want to buy the stock and hold on to it, causing its market worth to shoot through the roof. But sometimes, this can be misleading if the information is incorrect or does not reach all the market participants simultaneously. To protect the investors’ interest, the Securities and Exchange Board of India [SEBI] defines circuits – upper circuits and lower circuits – to set the maximum and minimum price levels to which stocks can fluctuate within a day.
What is Upper Circuit?
An upper circuit in the stock market is the maximum level or price to which a stock can move in a day. Once a stock touches its upper circuit, it means there are only buyers available and no sellers are present.
The upper circuit limit may be set to 20%, 10% or 5% on the previous day’s closing price, depending on the stock exchange’s criteria for a given stock. For instance, the first time a stock breaches its upper circuit, the exchange may apply a circuit limit of 20% on the previous day’s closing price. Then, if it continues to hit its upper circuit, the limit may be lowered sequentially to 10% or 5% to limit excessive trading activity. Lower circuit limits for the stock is also defined in the same way.
Once a stock hits its upper circuit, it cannot move any higher on that day, but it can go lower in case there is a fresh supply of shares in the stock market. However, stocks traded in the derivatives segment don’t have any circuit filter limits.
Stock indices like Nifty and Sensex also have circuit limits of 10%, 15% and 20%. If the index hits the lower or upper circuit, trading will be halted for some time.
Additional read: Things to Know While Doing Intraday Trading
Why do stock prices hit Upper Circuit limits?
A sudden demand for a stock could occur due to a news announcement such as management change, new product development or any other positive development. Buyers would then flock to buy the stock. However, you would see high volatility in the stock for a brief period, causing the stock price to rise rapidly. To prevent this from happening, the SEBI uses the upper circuit as a criterion to regulate price fluctuation.
Why are Upper Circuit limits instituted?
SEBI has initiated upper circuit limits for several reasons. For instance:
- They help regulate excessive price fluctuation on a single day
- They function as market curbs in case of a euphoric buying day
- They also help curtail stock price manipulation by traders in the market
Where can you find the Upper Circuit limit?
While SEBI oversees the circuit limits, they are actually declared by individual exchanges daily. Stock exchanges reveal stock filters on their website every day.
In addition, if the volatility in stock continues, the exchange can transfer the stock in the T2T segment, where delivery becomes compulsory. This decision is also announced on the stock exchange’s website.
The circuit limit is crucial to managing trading activity in the stock market. If stock prices were allowed to go up or down indefinitely, some traders would manipulate the prices to profit excessively. That is why the SEBI and stock exchanges place circuit limits to keep a check on extreme stock prices movements.
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