What are Upper Circuit and Lower Circuit in Share Market

In the Indian stock market, an upper circuit and a lower circuit are mechanisms that are used to regulate extreme price movements of stocks or securities. These circuit filters, also known as price bands, are put in place to prevent stocks from being overbought or oversold, which could result in volatile market conditions.

An upper circuit is the maximum percentage increase in the price of a stock in a single trading session. When a stock hits its upper circuit, trading in that particular stock is temporarily suspended. This is to prevent investors from continuously buying the stock at inflated prices, which could cause a market bubble.

On the other hand, a lower circuit is the maximum percentage decrease in the price of a stock in a single trading session. When a stock hits its lower circuit, trading in that particular stock is also temporarily suspended. This is to prevent investors from continuously selling the stock at deflated prices, which could cause a market crash.

It is important to note that upper and lower circuits are calculated based on the previous closing price of the stock. The percentage increase or decrease is predetermined by the stock exchange and varies from stock to stock. The circuit filters are put in place by the Securities and Exchange Board of India (SEBI) to promote stability in the stock market.

Investors need to be aware of the circuit filters when making investment decisions. For example, if a stock is trading close to its upper circuit, it may not be a good time to buy that stock, as the chances of a price correction are higher. Similarly, if a stock is trading close to its lower circuit, it may not be a good time to sell that stock, as the chances of a price rebound are higher.
 

Upper and lower circuits for stocks

Stock exchanges set up a price band for each stock based on its last traded price. This is done to protect investors from sudden and extreme price fluctuations in a single trading session. These price bands are commonly referred to as upper and lower circuits.

The purpose of setting up these price bands is to protect investors from the drastic volatility of the stock market. Stock prices are affected by a range of factors such as news, events, and market sentiment. Without these circuit filters in place, investors may panic and make hasty decisions, leading to market bubbles or crashes.

By putting these circuit filters in place, investors are assured of some stability in the stock market. They can make informed decisions based on prevailing market conditions without having to worry about sudden and extreme price movements.
 

Upper and lower circuits for indices

In addition to individual stocks, upper and lower circuits are also applied to stock indices in the Indian stock market. A stock index is a benchmark that represents the overall performance of a group of stocks in a particular market. Some examples of stock indices in the Indian market include the BSE Sensex and the NSE Nifty 50.

In India, a circuit breaker is triggered when the index experiences a 10%, 15%, or 20% rise or fall. If the index moves by 10% after 2:30 pm, trading will continue, as end-of-day trading is typically more volatile. However, if the movement occurs between 1 pm and 2:30 pm, trading will be halted for 15 minutes. If it happens before 1 pm, trading will be suspended for 45 minutes.

If the index moves by 15%, trading will be halted for the remainder of the trading day if it occurs after 2:30 pm. If the movement happens between 1 pm and 2:30 pm, trading will be suspended for 45 minutes. If it occurs before 1 pm, trading will be suspended for 1 hour and 45 minutes.

If the index experiences a 20% rise or falls at any time during the trading day, trading will be suspended for the day. This circuit breaker system helps prevent extreme market volatility, protects investors from significant losses, and provides them with time to reassess their positions.
 

What drives the upper/lower circuit?

The forces of demand and supply are the most fundamental drivers that lead a company to reach the point of upper or lower circuit in the Indian stock market. However, several other factors can also impact the demand and supply of a particular stock or index, leading to its maximum high or low price points. 

Below are the details about the same: 

Change in the structure of the organization due to mergers and acquisitions

When two companies merge, investors may anticipate an improvement in the financial performance of the newly formed company, leading to an increase in demand for its stock. Similarly, when a company acquires another company, it may lead to a decrease in demand for its stock due to the additional debt burden it may take on.

Political disturbances 

This can also impact the demand and supply of stocks. Unrest, instability, or conflict in a country can lead to a decrease in investor confidence, causing a fall in stock prices. On the other hand, political stability and favorable policies can lead to an increase in investor confidence and a rise in stock prices.

Changes in trade agreements 

This is another factor that impacts the demand and supply of stocks. A favorable trade agreement can lead to an increase in demand for stocks of companies that stand to benefit from the agreement. Conversely, an unfavorable trade agreement can lead to a decrease in demand for such stocks.

Changes in interest rates

An increase in interest rates can lead to a decrease in borrowing and investment, leading to a fall in stock prices. Conversely, a decrease in interest rates can lead to an increase in borrowing and investment, leading to a rise in stock prices.

Financial performance of a company 

This is another critical factor that impacts the demand and supply of its stock. A company with strong financial performance is likely to attract more investors, leading to an increase in demand for its stock. On the other hand, a company with weak financial performance is likely to discourage investors, leading to a decrease in demand for its stock.

Expansions, insolvencies, and consolidations 

When a company announces an expansion, investors may anticipate an increase in its future revenue, leading to an increase in demand for its stock. Conversely, when a company faces insolvency or consolidation, investors may anticipate a decrease in its future revenue, leading to a decrease in demand for its stock.

Investor confidence 

Positive news about a company or index can lead to an increase in investor confidence and a rise in stock prices. Conversely, negative news about a company or index can lead to a decrease in investor confidence and a fall in stock prices.
 

Five essential facts related to the upper and lower circuit

Here are five essential facts related to the upper and lower circuit:

1.    Circuit filters are implemented on the previous day's closing price. This means that the upper and lower circuits are calculated based on the previous day's closing price of the stock.

2.    You can find the circuit filters on the stock exchange's website. The upper and lower circuit levels are publicly available information and can be easily found on the website of the stock exchange.

3.    Stocks generally start with a 20% circuit. This means that the circuit limit is set at 20% of the previous day's closing price of the stock.

4.    When a stock hits its upper circuit, it means that the stock's price has increased by the maximum limit allowed for the day. In such a scenario, there are only buyers and no sellers for that stock. Similarly, when a stock hits its lower circuit, it means that the stock's price has decreased by the maximum limit allowed for the day. In this scenario, there are only sellers and no buyers for that stock.

5.    Intraday trades are converted to delivery when the upper or lower circuit is hit. When a stock hits its upper or lower circuit, intraday trades are automatically converted to delivery trades. This is because trading in that particular stock is halted for the rest of the day, and the only way to trade in that stock is through delivery.
 

How to use circuits or price bands on stocks to your advantage

Circuits or price bands on stocks can be used to your advantage in several ways:

Plan your investment strategy

Before investing in a stock, it is important to check the circuit limit set for it. This can help you plan your investment strategy, especially if you are looking for short-term gains.

Use circuit filters to minimize losses

Circuit filters can help you minimize losses in case a stock price falls sharply. If a stock hits its lower circuit, it is advisable to exit the stock and avoid further losses.

Invest in stocks with higher circuit limits

Investing in stocks with higher circuit limits can be beneficial, as they have the potential for higher returns. However, it is important to do your research and due diligence before investing in any stock.

Don't rely solely on circuit limits

It is important to note that circuit limits are not foolproof and cannot guarantee returns. Other factors such as company performance, market conditions, and global events also impact stock prices.

Conclusion

Circuits are implemented by stock exchanges to safeguard investors from extreme volatility in the market. Understanding the upper and lower circuits, and how they work is crucial for investors to make informed decisions and mitigate risk. While circuits can limit trading opportunities, they can also present opportunities for profit if used correctly. By staying informed on the latest market news and trends, investors can identify stocks that are likely to hit their circuit limits and make informed decisions based on that information.