What do you do when you come across a speed breaker, you just press the brakes and slow down the speed of your vehicle. Speed breakers are used to curb the speed of the vehicle.
Having said that let’s go through the definition.
Circuit Filter:- It is a price level beyond/below which stock price cannot rise/fall on a single day.
It is imposed to curb excessive volatility in a security a particular company. It may be 2%, 5%, 10%, 20%, 40% of previous days closing price. 2% and 40% are used rarely but 5% 10% and 20% are the most commonly used circuit filters.
Q) Who decides the circuits?
There are 2 types of circuit filters.
- Upper Circuit:- The topmost price beyond which the share cannot move up on a single day is called the upper circuit. It is typically characterized by all buyers and no/very few sellers.
- Lower Circuit:- The bottom-most price beyond which the share cannot move down on a single day is called a lower circuit. It is typically characterized by all sellers and no/very few buyers.
Q) Can stock open or close at the upper or lower circuit?
A) Yes, why not.
Market Wide Circuit Breaker:- It is same as circuit filters but the only difference is that the circuit filter is for a particular stock and market-wide circuit breakers are for the entire market say NSE or BSE.
Q) Who decides the market-wide circuit breaker?
A) SEBI (Securities and Exchange Board of India)
Q) Why it is necessary to apply circuit filters?
A) When the exchanges or SEBI feel that there is no speculation or gambling in the market and the company is fundamentally strong then they do not apply the breakers at 2% or 5%.
But when they feel that speculation is going on in the market that’s where they step in and reduces the limit to 2% or 5%.
Let us assume an example with a 20% breaker.
Suppose, the share price of a particular company closes at Rs. 80 on day 1. As shown in fig.1
On day 2, assuming a 20% limit, the breakers will be calculated on the basis of previous days’ closing price. As shown in fig.2
If exchanges feel that speculation is going on then they can reduce the limit overnight to prevent the loss of investors.
For eg. If they reduce it to 5%, then the upper and lower limit would be Rs. 84 and Rs. 76 respectively.
Q) How to know the circuits of a particular stock?
A) It is given as L/U Band on any website or any stock trading app.
Q) Tata share price fall by 20% and Yes Bank rose by 22% in a single day even when there was a filter, how is it possible?
A) There are exceptions to every rule. There are some companies for which circuit filter is not applicable. The exception is that if the stock is listed in the F&O segment i.e (derivative segment) than for those stocks circuit filter is not applicable.
Actually, there is a filter but the moment the price hits the limit another 10% circuit filter is opened and it can rise another 10% and on and on and on. This happens with big stocks only because penny stocks are not available in the derivative segment.
Exceptions:- Circuit filters will not apply if
- The stock is also listed in the F&O segment.
- If it is the first day of listing of the stock on the secondary market.
Q) How to know whether the stock is in the F&O segment or not?
A) Everything is available on website BSE NSE or moneycontrol.com