How Much Do Stocks Have to Drop Before Trading is Halted? The Details on Market 'Circuit Breakers'

In the fast-paced world of stock trading, market volatility can lead to extreme price movements that can destabilize the entire market. To prevent such scenarios, exchanges have implemented a system of circuit breakers that halt trading temporarily or for the remainder of the trading day. These circuit breakers are designed to curb panic-selling and allow the market to stabilize. Let's delve into the details of how these circuit breakers work and what triggers them.

Market-Wide Circuit Breakers: The Three Levels

Market-wide circuit breakers are triggered by significant declines in the S&P 500 Index. There are three levels of circuit breakers, each with its own set of triggers and impacts:

1. Level 1 (7% drop): If the S&P 500 Index drops by 7% before 3:25 p.m. ET, trading is halted for 15 minutes. This halt is intended to give investors time to absorb the information and make informed decisions. However, if the 7% drop occurs at or after 3:25 p.m. ET, trading continues without a halt. This is because the market is nearing its close, and a short halt would not be as effective in preventing panic selling.

2. Level 2 (13% drop): Similar to Level 1, a 13% drop in the S&P 500 Index before 3:25 p.m. ET will also halt trading for 15 minutes. This halt is more severe than Level 1 and is designed to curb even more significant panic selling. If the 13% drop occurs at or after 3:25 p.m. ET, trading continues without a halt.

3. Level 3 (20% drop): A 20% drop in the S&P 500 Index at any time during the trading day will halt trading for the remainder of the day. This is the most severe level of circuit breaker and is designed to prevent a market crash.

These circuit breakers are set by the markets at point levels that are calculated daily based on the prior day’s closing price of the S&P 500 Index. For example, if the S&P 500 Index closed at 5,074.08 on Friday, the thresholds for the different circuit breakers to be triggered during Monday's session would be: Level 1 at 4,718.89, Level 2 at 4,414.45, and Level 3 at 4,059.26.

Single-Security Circuit Breakers: The Limit Up-Limit Down (LULD) Rules

While market-wide circuit breakers affect the entire market, single-security circuit breakers are designed to halt trading in individual stocks or ETFs that experience large, sudden price movements. These circuit breakers are triggered when a stock's price moves outside a specified price band, which is set at a percentage level above and below the average price of the stock over the immediately preceding five-minute trading period.

The price bands are different for Tier 1 and Tier 2 NMS stocks:

- Tier 1 NMS stocks (S&P 500, Russell 1000, and select ETPs): 5% during regular trading hours and 10% during the last 25 minutes of the trading day.
- Tier 2 NMS stocks (all other NMS securities except rights and warrants): 10% during regular trading hours and 20% during the last 25 minutes of the trading day.

If the stock’s price moves to the price band and does not move back within the price bands within 15 seconds, trading in the stock will pause for five minutes. For example, if XYZ Corp's stock is trading at $50 per share and news about a product recall causes a rapid drop in the stock price, exceeding the lower band for 15 seconds will pause trading for 5 minutes.

The Impact of Circuit Breakers on Trading

Circuit breakers play a crucial role in maintaining market stability during times of extreme volatility. They provide a temporary pause that allows investors to absorb information and make informed decisions, rather than reacting impulsively to sudden price movements. This can help prevent panic-selling and market crashes.

However, it's important to note that circuit breakers are not a foolproof solution. They are designed to provide a "breather" during times of extreme volatility, but they cannot prevent all market crashes. For example, during the 2020 COVID-19 sell-off, the S&P 500 Index triggered four separate market-wide circuit breakers, but the market continued to experience significant volatility.

In conclusion, circuit breakers are an essential tool for maintaining market stability during times of extreme volatility. They provide a temporary pause that allows investors to absorb information and make informed decisions, rather than reacting impulsively to sudden price movements. However, they are not a foolproof solution and should be used in conjunction with other risk management strategies.