Why Market Circuit Breakers Keep Halting Trading

If you have been following the financial markets closely over the past month, you probably noticed that trading has been completely halted on more than one occasion. These market-wide halts are extremely rare and a sign of just how volatile the stock market is at this point in time. It’s hard to believe that the market simply stops trading after a certain price level is hit, but that is the reality.

You might be wondering why these trading halts exist and whether or not they are a good or a bad thing for investors. Let’s take a look at why market circuit breakers keep halting trading below.

What is a Market Circuit Breaker?

In order to understand why market circuit breakers exist, it helps to look back into history and recall the stock market crash of October 19^th, 1987. On that day, the Dow Jones Industrial Average dropped a whopping 22.6% in a single day. This massive downward movement in a single trading session came to be known as Black Monday. The devastating losses that occurred that day forever left their mark on the finance world. There was nothing to stop the massive panic and freefall in the market on Black Monday, which ultimately led the Securities & Exchange Commission to create the market circuit breakers we see functioning today.

The goal of a market circuit breaker is to prevent the stock market from falling down to extreme levels in a single trading session. They are meant to help us avoid massive single-day crashes like what occurred on Black Monday in 1987. Panic is an emotion that can lead to rash decisions in the market, and the objective of the circuit breakers is to prevent or slow panic selling to extreme levels.

There are 3 levels to market circuit breakers. If a major index like the S&P 500 or Dow Jones Industrial Average falls by 7% from its previous close in a single session, a level 1 circuit breaker comes into effect. This is what we have seen happen multiple times in March. After the Level 1 circuit breaker is triggered, trading is completely halted for 15 minutes and then resumes after that period. If the selling continues after the halt, a level 2 decline can occur when an index drops 13% from its previous close. Level 2 circuit breaker limits lead to another 15 minutes of halted trading. If an index drops 20% in a single trading day, trading is halted for the remainder of the day.

Prior to the current selloff in 2020, market circuit breakers had only been used once, in October 1997. It’s astonishing to think that we have seen circuit breaker limits hit 4 different times already in March, which is a testament to just how volatile and uncertain things are in financial markets.

Are Market Circuit Breakers Good or Bad?

There is a debate in the finance community over whether or not market circuit breakers are truly effective. One can argue those circuit breakers are a good thing because they allow markets to take a breather during intense selling. It allows market participants to stop and digest the price action for a short period of time. New York Stock Exchange President Stacey Cunningham stated that circuit breakers “are designed to slow trading down for a few minutes, to give investors the ability to understand what’s happening in the market, consume the information, and make decisions based on market conditions,”

On the other hand, some investors believe that circuit breakers actually speed up the selling process. Since everyone knows there is a circuit breaker level approach, it can become a self-fulfilling prophecy and lead markets to sell-off until they are halted. Also, since circuit breakers stop all orders from being processed and allow them to stack up during the halt, it’s possible that these circuit breakers add to the market volatility when the 15 minutes trading halt concludes. You could also argue that market circuit breakers reduce liquidity in the market for a short period of time, which can add to the panic during a massive selloff.

Uncertainty Ahead

You know that the market is volatile when you start to see circuit breakers halting trading on a consistent basis. It is critically important as both investors and traders to understand that the stock market is driven by human emotion. When things are uncertain and fear dominates the headlines, circuit breakers are designed to come into play to allow people to review the current market activity with a level head.