What is Upper Circuit and Lower Circuit in Share Market?

What is Upper Circuit and Lower Circuit in Share Market

It’s a given fact that stock markets are volatile in nature. Investors have frequently suffered significant losses as a result of abrupt price swings. “Upper Circuit” and “Lower Circuit” refer to price limitations set by regulatory bodies to guarantee orderly trading. These circuits protect investor interest by establishing maximum and lowest price levels for stock changes on a given day.

For traders and investors, knowing what is upper circuit and lower circuit are is essential as they have an immediate influence on risk evaluation, decision-making procedures, and market mood in general. Furthermore, becoming acquainted with these techniques helps to comprehend the subtleties of price fluctuations and market dynamics in the context of the Indian stock exchange.

What is Upper Circuit?

A stock exchange-imposed upper price limitation that restricts a stock from being traded on a given trading day is known as an upper circuit. This pause gives market players time to process new information and eliminates dramatic price swings that can jeopardise the stability of the market.

Upper circuits promote orderly behaviour in the market while safeguarding against speculative trading. Investors won’t be able to purchase or sell shares of the impacted stock until trade has resumed during the pause caused by an upper circuit.

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What is Lower Circuit?

Now that you know what the upper circuit is, let’s look at what is lower circuit in share market. A lower circuit is the price at which trading in a stock stops for the day in order to prevent additional price declines.

Market players may reconsider their positions and process the effect of noteworthy unfavourable events during this period. Lower circuits are usually set off by significant negative news or events pertaining to the company or more widespread market circumstances.

Now that you know what is lower circuit and upper circuit are, let us look at their applications.

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Upper and Lower Circuits for Stocks

Every day, stock exchanges establish a price band depending on the stock’s last traded price (LTP). This is being done in an effort to shield investors from sharp daily fluctuations in prices.

The purpose of upper and lower circuits in stock markets, as mentioned in the paragraph above, is just to shield investors from the extreme volatility of the stock market as a whole.

The stock market may decide the limit, which might be expressed as a percentage. It might be in the range of 2% and 20%.

For example, there is a 20% circuit for a share trading at Rs 200 today. This implies that during the trading session, the share price cannot decrease by more than 20% or rise by more than 20%. During the day, the price will only fluctuate between Rs 180 and Rs 220, even if the corporation discovers a gold mine beneath its office buildings.

Upper and Lower Circuits for Indices

Circuits aren’t limited to being utilised with individual stocks; they may also be applied to indices. When an index changes by 10%, 15%, or 20%, the circuit breaker system indicates a danger.

Trading is stopped in India’s derivatives markets as well as the stock markets when this occurs. This pause may extend for a few minutes or the whole trading day. It is dependent upon the index’s percentage decline.

  • 10% rise or fall
    1. Nothing much happens if an index changes by 10% after 2:30 pm. This is most likely justified by the fact that there’s usually more volatility towards the end of the trading day.
    2. A 10% increase or decrease in market activity occurs between 1:00 and 2:30 pm, causing a 15-minute break. However, if it changes by 10% before 1:00 pm, trading is suspended for 45 minutes.
  • 15% rise or fall
    1. Trading is suspended for the duration of the trading day if the index rises or falls by 15% after 2:30 pm.
    2. Trading is stopped for 45 minutes if an index changes by 15% at any point between 1:00 and 2:30 pm.
    3. Trading is put on hold for one hour and forty-five minutes if it changes by 15% before 1:00 pm.
  • 20% rise or fall
    1. If an index shows a 20% increase or decrease at any time throughout the day, trading is paused.

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What Causes Upper/Lower Circuit?

The dynamics of supply and demand are the primary factors that cause a company to enter an upper or lower circuit. However, a number of additional factors can also influence these dynamics and cause an index or stock to reach its maximum high or low price points. Some of such factors include:

  • Financial Performance of the Company
    Investors’ reactions to a company’s financial performance, like falling revenues or increasing losses, might set upper or lower circuit limitations. On the other hand, spectacular financial outcomes that surpass market expectations might cause higher circuits because of heightened investor demand.
  • Organisational Structure Changes Through Mergers and Acquisitions
    When two companies come together, investors might predict the newly created company will do better financially, which will generate interest in its shares. Similar to this, if one company buys another, the more debt that the new company may incur might cause the market for its shares to decline.
  • Trade Agreement Modifications
    Changes to trade agreements that affect a company’s market access, imports, or exports may have an upper or lower circuit impact on its financial prospects.
  • Conflict in Politics
    Economic activity and investor confidence can be negatively impacted by turmoil in politics or instability, which can cause volatility in the market and generate upper or lower-circuit triggers.
  • Investor Confidence
    Dramatic changes can influence both upper and lower circuit movements in market mood driven by macroeconomic, regulatory, or geopolitical developments.
  • Interest rate fluctuations, including repo and reverse repo rates
    Interest rate changes, mainly set by the RBI, can have an impact on liquidity, borrowing costs, and investor behaviour. They can also result in upper or lower circuit triggers.
  • Consolidations, insolvencies, and expansions
    Corporate bankruptcies, mergers, and expansions can affect how the market views a company’s potential for growth, and depending on how investors respond to these changes, this might result in upper or lower circuit triggers.

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How Can You Use Circuits or Price Bands on Stocks to Your Advantage

  • Understand the Basics
    Get familiar with the concept of circuit limits.
  • Risk Management
    Circuits serve as barriers against excessive market volatility, reducing sudden and rapid fluctuations and aiding investors in risk management.
  • Use circuit filters to reduce loss
    Circuit filters can reduce your losses in the wake of a sharp drop in the price of stocks. It is best to sell a stock when it reaches its lowest circuit to prevent more losses.
  • Trading Strategies
    Use circuit limits to guide your trading strategies. For example, to buy or sell stocks more successfully, use limit orders at circuit levels.
  • Long-Term Planning
    Recognise the importance of circuit limitations in preserving stability and avoiding illogical price fluctuations, and include them in your long-term investment planning.
  • Market Sentiment Analysis
    Be careful of how stocks respond when they get close to circuit limitations since a violation of these levels may signal significant shifts in the behaviour of the market or underlying issues.

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Investor Protection Through Circuits By SEBI

Investors should understand that the purpose of these circuit breakers is to safeguard their best interests. The Securities Exchange Board of India, or SEBI, has made it a priority to protect investors against fraudulent activity in the market. One such step towards frauds like price-rigging and market dominance is the application of circuit breakers.

Real-time investors need to perform due diligence when making stock investments by learning about the company’s financial situation and the fundamentals of how the Indian stock market operates rather than succumbing to the herd mentality.

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Conclusion

Stock exchanges implement circuits to protect investors from excessive market volatility. Investors need to comprehend the functioning and know what is upper circuit and lower circuit are in order to reduce risk and make wise decisions.

When projecting your price movement as an investor, remember to take into account a stock’s circuit. Beware not to rely on all of your trading decisions on stocks hitting higher or lower circuits.

Circuits can restrict trading opportunities, but when used properly, they can also offer lucrative possibilities. Investors may identify stocks which are likely to reach their circuit boundaries and make well-informed judgements by keeping up with the latest market news and trends.

Author:
All Content is verified by SMC Global Securities.

Reference:
https://www.bajajbroking.in/
https://www.businesstoday.in/

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