What Are Upper Circuit and Lower Circuit in Stock Market?

The upper circuit is the maximum price a stock can achieve on a specific trading day, while the lower circuit is the maximum price a stock can achieve on a specific trading day.

Introduction

We've all fantasised about selecting a stock and earning returns of 50%, 100%, or even 1,000% the day we invest in it. Regrettably, circuit boundaries beyond which a stock's price can not move may prevent this from being possible. The upper and lower circuits are decided by the Securities and Exchanges Board of India in India.

Here, we define upper and lower circuits, describe potential stock routes to them, and and what happens when equities or indices do. In June 2021, a number of the Adani Group's equities began trading below their lower circuits. Trading was suspended to prevent potential stock manipulation while many novice investors watched uncertainly about what to do or anticipate.

Many investors may have felt as though they were being punished, yet the action was actually taken to protect investors. A volatility safety net for investors could be referred to as the circuit breakers put in place by SEBI. Let's learn more about them and how to use them.

Stock markets are notorious for their erratic behaviour. Investors have frequently suffered significant losses as a result of sudden market swings. SEBI (Securities and Exchange Board of India) created circuits (upper and lower) that define the maximum & lowest price levels to determine stock movements during a day in order to protect an investor's interests. As an investor, you should keep in mind that a stock's price cannot move above its upper circuit in a single trading session.

The price may drop when a stock is under sell pressure, and there are not enough buyers. Lower circuits are determined by the previous day's closing price, which can change from stock to stock. The "upper circuit" refers to the highest price a stock can achieve on a specific trading day, and the "lower circuit" refers to the lowest price a stock can achieve on that same trading day.

What Is The Upper Circuit? 

The highest point is on the upper circuit where a stock's price or index's value can increase in a single day. Stocks with many buyers but few sellers could reach the upper circuit. Upper circuits are computed using the closing price from the previous day.

Some equities may have upper circuits that are 2% above their closing price from the previous day. Other stocks may have upper circuits that are 5%, 10%, or 20% higher than their day-ago closing levels.

A stock's price is not permitted to increase above its upper circuit in a single trading session. However, if some start selling, the prices can fall.

What Is The Lower Circuit? 

The lower circuit is the lowest point at a stock's price, or an index's value might drop. Stocks that many people want to sell but that hardly anyone is buying could fall in price. Lower circuits are likewise computed using the previous day's closing price, although they may vary from stock to stock.

The lower circuit could be 2% lower than the previous closing price for some equities, 5%, 10%, 15%, or 20% lower than the previous closing price for other companies.

In a single trading session, a stock's price may not drop below its lower circuit, but if investors start purchasing the stock, its price may rise.

Upper And Lower Circuits For Stocks

Let's split up the conversation into two sections—stocks' upper and lower circuits and indexes' upper and lower circuits.

Every day, stock exchanges establish price bands based on the stock's most recent traded price. It is being done to safeguard investors from wildly volatile single-day price changes (hike & drop). The purpose of upper and lower circuits (as mentioned in the preceding paragraph) in the stock market is to shield investors from the market's extreme volatility.

The stock exchanges set up a price band each day based on the stock's most recent traded price to safeguard investors from a significant single-day reactionary share price decline or boost. The upper circuit is the highest price at which the stock may trade on the specified day. As you might have anticipated, the stock price can only trade as low as the lower circuit on that particular day.

The stock market's use of upper/lower circuits is solely intended to safeguard investors.

The stock market's determination of a number, expressed as a percentage may be used to set the limit. Anywhere between 2% and 20% is possible.

For example:

Stock Today's share price of 100 rupees has a 20% circuit. Therefore, neither the share price nor its growth during the trading session may be greater than 20%. Even if the business discovers a gold mine beneath its office space during the day, the price will only fluctuate between Rs 80 and Rs 120.

Why Do Stocks Hit Upper or Lower Circuits?

The forces of supply and demand, which the market freely applies, are the only factors that affect stock prices. A stock's price will increase if demand outpaces supply, and it will decrease in value as demand decreases.

You might be asking yourself, "If the share's value is determined by supply and demand, does the operation quality of the business matter at all?" Yes, it is unquestionably relevant in response to this query. I'll tell you how.

As the business succeeds, knowledge of this successful operation travels among shareholders and other investors. Investors can now own a piece of the business by purchasing a share.

People want to participate directly in the company in order to profit from improvements as the business grows. Both current shareholders and new owners desire to grow their stakes in the company.

It indicates that there is a rise in interest in the share. It indicates that individuals are willing to pay more for that particular share up to a certain point. And to meet this demand, the price goes up in line.

Let's look at some examples of stocks touching the upper or lower circuit to understand better why stocks may do so.

A stock reaches its upper circuit when it...

Consider a scenario in which a new automaker unexpectedly surpasses the market leader in terms of market share, resulting in a spike in demand for this stock.

Such a company's stockholders are not likely to sell their shares. However, buyers may offer higher prices for these stocks. Upper circuits can shield investors from volatility and unwarranted speculation like the pump-and-dump operation on Telegram that was exposed in January 2022, preventing a stock's price from rocketing in a single day.

On January 12th, 2022, SEBI accused the administrators of a Telegram group of making illegal gains totalling 2.84 crores by purchasing specific stocks, suggesting them to their users, and then selling these shares for a tidy profit.

A stock is in the lower circuit when it...

Let's say there is news that a specific business was engaging in unethical business practices. On this corporation, the government is anticipated to take harsh action. The shares of this corporation are now undesirable. As no one would be interested in purchasing, the current stockholders will not be able to sell their shares.

A stock's price may decrease if no one is purchasing it. The stock price may continue to decline due to investors' concern about buying stocks that are already in decline. Lower circuits are set in order to avoid this.

Example of a stock hitting a lower circuit

From April 25 to May 12, 2022, Future Retail's stock price fell every trading session. In a month, the stock's price dropped by about 50%. (from 13th April to 12th May).

Events That May Lead a Stock to Hit Its Upper or Lower Circuits

We frequently hear that supply and demand factors influence stock prices. You must be aware of the supply and demand levels that will cause a circuit to be tripped.

Therefore, in theory, a stock could reach its circuit boundaries as a result of any occurrence that alters how desirable a stock is. A stock must see a significant appeal change to reach the upper or lower circuit. Market manipulation occasionally also results in equities hitting their upper or lower circuits.

A stock may hit its upper or lower circuits as a result of the following circumstances:

• Earnings that exceed or fall short of expectations

• Political ambiguity

• Geopolitical constraints

• Shifts in investor confidence resulting from precipitous drops or gains in international stock markets

• Alterations in interest rates

• Consolidation or fiscal growth

• Alterations to the trade scenario (trade agreements, economic zones, tariffs, etc.)

• Competitors' superior or inferior performance

What Are Market-wide Circuit Breakers?

When market-wide circuit breakers are activated, all equities and equity derivative markets in India come to a coordinated halt. Circuit breakers suspend trading on the NSE and BSE at three points in the movement of their respective indices.

Following each halt, the NSE and BSE both resume trading with pre-open call auction sessions.

On March 13, 2020, the Nifty 50 plummeted by 10% in early trading, necessitating the 45-minute suspension of both NSE and BSE.

Upper And Lower Circuits For Indices 

Not only for individual stocks, but also index circuits may be used. The circuit breaker mechanism triggers an alarm when an indicator dips or climbs by 10%, 15%, or 20%. When this occurs, trade is suspended in India's equities markets as well as its derivatives markets.

The suspension could be in effect for a short while or the rest of the business day. It depends on how much the index rose or fell in percentage terms.

10% rise or fall

After 2:30 pm, nothing actually happens if an index increases or decreases by 10%. It is mainly due to the fact that volatility is usually higher near the conclusion of the trading day.

A 15-minute stoppage in trading activity is triggered by a 10% increase or decrease between 1:00 and 2.30 pm.

However, a 45-minute halt in trading activity is triggered if it increases or decreases by 10% before 1 pm.

15% rise or fall

Trading is suspended for the balance of the trading day if the index rises or falls by 15% after 2.30 pm.

Trading is paused for 45 minutes if an index moves up or down by 15% at any time between 1:00 and 2:30 pm.

A 1-hour, 45-minute trading pause is imposed if it increases or decreases by 15% before 1:00 pm.

20% rise or fall

Any time an index has a 20% spike or fall, trading is suspended for the remainder of the day.

5 Essential Facts Related to Upper and Lower Circuit

The term "stock markets" refers to a group of all places where shares of publicly traded companies are issued, purchased, and sold. The buyers and sellers of shares are two examples of the participants in the stock market. The majority of us picture the common Joe from the public who trades or invests in stocks when we think of "buyers and sellers." They are referred to as retail investors.

However, they are not the only people trading stocks. The stock market is not just home to ordinary retail investors but also institutions like mutual funds, pension funds, investor organisations, banks, etc.

Many of you have seen news items about specific shares hitting their "upper circuits" or "lower circuits" as investing becomes a more popular concept and a greater market segment. But what do these terms actually mean?

Price ceilings, known as upper and lower circuits, can be applied to specific equities or indices. These two types of circuit breakers are the ones used in the stock market as a whole. Yes, circuit breakers are used in stock markets. Yes, the same ones resemble vintage switches and are frequently misreferred to as "fuses" in casual discussions.

1. Circuit filters are applied on the closing price from the previous day.

2. The circuit filters are available on the stock exchange's website.

3. A 20% circuit is the default starting point for stocks.

4. If a stock reaches its upper circuit, all buyers and all sellers will be present; conversely, if a stock reaches its lower circuit, all sellers and all buyers will be present.

5. In these circumstances, intraday trades are changed to delivery trades.

How to Use Circuits or Price Bands on Stocks to Your Advantage?

Avoid stocks that frequently hit their circuits or stocks that show extremely frequently altered circuits if you are a novice trader. These actions clearly indicate that the exchange is worried about trading activity associated with these stocks and should serve as a warning to you. When the circuit is approaching 5% or lower, it is preferable to sell if you have already invested in a stock. Low earning potential typically also accompanies very little volatility.

A circuit breaker is a device installed in the stock markets to protect investors from wildly fluctuating prices. Every stock has a specified upper and lower circuits that are activated when they reach this price level, as do indices. It is referred to as a price band, and the circuit breaker is activated when the stocks reach either the upper or lower level established. This circuit breaker suspends trade for a predetermined amount of time, allowing investors to respond to volatility without becoming alarmed. The details of the two types of circuit breakers that are available in India are provided below.

Upper and lower circuits of the stock market's circuit breakers

The upper and lower limits specified for certain equities are known as circuit breakers for stocks. These restrictions, which are specified as percentages, are set each day based on the stock's most recent trading price. These limits are activated when the stock exceeds either the upper limit or the lower limit of the price band. The stock market determines this price range, which can range from 2% to 20% of the stock price.

Final Thoughts

Circuit restrictions are established to shield investors from unwarranted volatility and speculation. Ideally, the price of the stock should only reach the lower and higher circuits when there is a shift in its desirability. However, market manipulators may occasionally attempt to affect the supply and demand for a stock. Investors should use caution when entering trades based only on the fact that equities or indices have reached their upper or lower circuits.

Investors risk losing a substantial amount of money in the event of abrupt movements. Circuit breakers were installed for this reason—to shield the investor from unpleasant surprises. Circuits can serve as both a safeguard and a warning sign for some businesses. When forecasting a stock's price movement, take into account the circuit.