18 Mar 2020 15:59 IST

How have markets moved after a circuit breaker trigger?

On all six occasions that the measure was imposed, markets stabilised over the next few days

The stock market hit a circuit breaker on March 13, amid panic selling. Trading in both Sensex and Nifty50 was halted for 45 minutes. This is not the first time that the circuit breaker has been triggered. In India, since market regulator SEBI (Securities and Exchange Board of India) introduced the regulatory measure in 2001, circuit breakers have been applied six times.

Of these six times, the market hit the lower circuit four times. An analysis of the near-term direction of the index movement following the application of a circuit-breaker reveals that in three of these six occasions, the market changed direction and ended with positive returns the following day and for the next week. The Nifty 50 index was considered for the calculations.

A report from 2017 on ‘Impact of market-wide circuit-breaker on trading activity and volatility: Empirical evidence from Indian markets’ by Latha S Chari, Pradiptarathi Panda and Sunder Ram Koviri, also indicates that though the volatility continues to be high and significant for up to two days, post the event day, the application of market-wide circuit-breakers actually helped calm the panic most of the times.

Commenting on the volatility on the day and the following days when the circuit-breaker was applied, the report notes that with the application of market-wide circuit-breakers, the steep price movements in the index are witnessed for a period up to three days post the event day.

However, it notes, the calculated high-low volatility measures showed that they fall gradually on subsequent days, moving towards the average levels over the period of three days.

Reverses direction

On May 17, 2004, the Sensex fell by 10 per cent, hitting the lower circuit, in the wake of the UPA coming to power. When the markets re-opened, there was a sharp fall again, triggering a second circuit breaker. However, with government assurance, the markets recovered a bit and ended lower by 12 per cent compared to the previous day. Next day, on May 18, 2004, the markets rebounded and ended with 8.3 per cent gains. And within a week (fifth working day from the day of market crash), markets recovered almost all the losses and ended 12.3 per cent higher from the close of the day on which the circuit breaker was applied.

Even in 2006 and 2008, when the lower circuits were applied — on May 22, 2006, when there was a concern on margin pressure and taxation; and on January 22, 2008, during the global financial crisis — Sensex ended the days lower by 5.1 per cent and 5.9 per cent respectively. But the bellwether index recovered on the following day, ending higher by 3.8 per cent and 6.2 per cent respectively in 2006 and 2008. By the fifth day from the crash, the Sensex recorded gains of 4.2 per cent and 7.7 per cent respectively from the closing values of days on which circuit breakers were applied.

The index also swung in the upper direction at times. The Sensex hit the upper circuit (at 15 per cent level) on May 18, 2009, when the UPA won the Lok Sabha elections. When trading resumed, the 20 per cent third circuit level was triggered and the market remained closed for rest of the day. On the following day — May 19, 2009 — the Sensex reversed the rising trend and fell marginally by 0.1 per cent. By the fifth day, the Sensex closed lower by 2 per cent compared to closing values of May 18, 2009.

The exception

There was an exception to this trend. On October 17, 2007, with the clampdown on promissory notes by SEBI, the markets triggered lower circuit and ended the day with losses of about 2 per cent. The sell-off intensified on the following day – October 18, 2007, when the markets fell by higher 3.7 per cent. Though there was a recovery to an extent in the following days, by fifth day, markets continued the falling trend and ended lower by 1.5 per cent from the closing value of the October 17, 2007.

Note that index movements post the application of circuit breakers on October 5, 2012 were not considered as the lower circuit on that day was triggered due to an error order punched by one of the brokerage houses.

From the above observations, it can be inferred (as also stated in the said report) that after application of circuit-breaker, the markets have recovered significantly from the day's lows in the same session. The index movement on March 13, 2020 too proved this. After hitting the lower circuit within a short time of market opening, the index recovered and closed the day higher by 3.8 per cent.

Also, in most of the cases, the trend of the index movement, that triggers the circuit breakers, did not continue on the following days.

This time around, the market fell sharply hitherto, after remaining somewhat flat on Tuesday (March 17). It remains to be seen how the market behaves for the rest of this week.