Trading Basics

December 27, 2024

Trading Circuit Breakers and Halts: How They Protect Markets and What Traders Should Know

When the stock market hits the brakes, it’s not just to slow things down. Instead, it is usually done to put an end to chaos. In this article, we will explain “circuit breakers” and “trading halts” to you. These are two major mechanisms that put trading on pause when things get too wild. These tools are crucial for protecting both traders and investors during times of extreme market volatility.

First, you’ll explore circuit breakers, which temporarily halt all trading in major indexes like the S&P 500 when prices drop too sharply. You’ll learn how they’re tiered based on percentage drops and how they’ve helped prevent market crashes since their introduction after the 1987 Black Monday crash.

Next, you’ll look into trading halts, which affect individual stocks rather than the entire market. They are triggered by major news or unusual price movements. Toward the end, you will learn how these mechanisms impact your trading strategies and what steps you can take to prepare for them. Lastly, we will explain how our advanced market analysis tool, Bookmap, can prepare you better for these halts and breakers. Let’s begin.

What Are Trading Circuit Breakers?

Trading circuit breakers are temporary pauses in the stock market. They are designed to prevent panic selling during significant declines in major indexes like the S&P 500. These mechanisms slow down rapid drops and provide time for traders to assess market conditions. This helps to avoid market crashes.

For Example:

Say the S&P 500 drops by 7%.
Now, trading halts for 15 minutes to give traders time to evaluate the situation.
The market drops further.
It reaches a 20% decline.
All trading stops for the day to prevent further instability.

For more clarity on the workings of the trading circuit, check the graphic below:

Circuit breakers ensure that the market stabilizes during high volatility and prevent crashes driven by panic selling. Some other key points are mentioned in the table below.

Tiered System Based on Percentage Drops	Gradual Halts as Drops Intensify
Circuit breakers are activated when the market experiences sharp drops, typically at 7%, 13%, and 20%. Each percentage level represents a different severity of market decline, with increasing measures to pause or stop trading.	A 7% drop triggers a 15-minute halt. It allows traders to reevaluate their strategies. A 13% drop causes another halt, often for a longer duration. If the market drops by 20%, trading stops entirely for the rest of the day.

Now, if we talk about some historical background, the use of circuit breakers was pioneered after the 1987 “Black Monday” crash. In this event, markets dropped 22% in a single day. This system was installed to avoid similar panic-driven selloffs in the future.

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Why Are Circuit Breakers Important in Stock Trading?

Circuit breakers maintain stability and order during periods of extreme market volatility. They temporarily halt trading, which prevents emotional reactions that could lead to market crashes. By doing so, they give investors and traders time to assess the situation and make more informed decisions. Let’s understand in detail:

Market stability

Investor protection

Circuit breakers restore market stability during times of extreme volatility.
In times of panic, many traders sell off their investments in a rush.
This creates a snowball effect that could lead to a market crash.
Circuit breakers slow down this process by halting trading when the market experiences significant drops.
This allows for a cooling-off period.
In this period, traders can reflect on their strategies instead of making rash and panic-driven decisions.

Circuit breakers give protection to individual investors.
Usually, in volatile markets, emotions run high, and investors are tempted to exit their holdings without fully understanding the ramifications of their decision to sell in a panic.
By halting trading, circuit breakers give investors the time to:

Gather more information,
Reassess their portfolios, and
Avoid making decisions driven by fear or panic.

This pause also prevents large institutional investors from exploiting rapid market fluctuations at the expense of smaller and individual investors.

Again, if we talk about history, the effectiveness of circuit breakers has been demonstrated time and again. One prominent example is the COVID-19 market crash in March 2020. In this period, circuit breakers were triggered multiple times due to the extreme volatility.

On March 9, 2020, the S&P 500 dropped by 7%. It triggered the first-level circuit breaker and caused a 15-minute halt in trading. Similar pauses occurred on March 12, March 16, and March 18, as the market continued to react to the pandemic. These trading halts reduced panic selling and gave investors time to adjust. Some other instances include the 2010 “Flash Crash” and the 2015 China market turmoil. Both these events saw circuit breakers getting triggered.

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What Are Trading Halts?

Trading halts are temporary pauses in the trading of individual stocks rather than the entire market. They are usually implemented due to specific reasons like:

Important news,
Regulatory matters, and
Unusual price movements.

These halts allow the market to absorb new information. Also, they prevent wild price swings caused by emotional reactions. Usually, there are three types of trading halts:

For a greater understanding, let’s study these key points.

Initiated by Exchanges

- - Trading halts are initiated by NASDAQ, the New York Stock Exchange (NYSE), or any other major exchange.
  - They help to protect market integrity.
  - The exchanges monitor stocks for unusual activity.
  - They decide to halt trading when a specific stock’s price fluctuates rapidly or when important news is announced that could significantly impact its value.

Purpose of Trading Halts

- - The primary purpose of a trading halt is to give the market time to process information.
  - These halts prevent erratic price movements.
  - If a stock experiences sudden and extreme buying or selling pressure, the halt acts as a buffer to prevent irrational trading behavior.
  - Also, this pause ensures that investors have the opportunity to:
    - Digest news
    - Perform analysis
    - Avoid making decisions based on raw emotion.

Duration of Halts

- - Trading halts are usually brief.
  - They last between 5 and 10 minutes.
  - Their length varies and depends on the circumstances.
  - If more time is needed for investors to process news or for the exchange to investigate unusual activity, the halt may be extended.

However, most halts are short, and trading resumes as soon as the market stabilizes.

For example:

Say a biotech company announces that it has received FDA approval for a groundbreaking new drug. Now, the stock could be subject to a trading halt. This temporary pause will allow investors to digest this news and prevent erratic buying or selling based solely on headlines.

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Different Types of Trading Halts

Apart from the three levels of circuit breakers, we also have certain trading halts that are implemented at specific times to ensure orderly trading. Let’s explore three main types of trading halts.

News Pending Halt

Volatility Trading Pause

Regulatory Halts

A news pending halt occurs when a company is about to release major information, such as:

Earnings reports,
Mergers, and
New product launches.

The halt gives the market time to pause and anticipate the release of this news.
This ensures that traders don’t react irrationally before fully understanding its implications.
This type of halt allows investors to process important news before making any trading decisions.
Also, it reduces the chances of emotional buying or selling.

- A volatility trading pause is triggered when a stock experiences rapid and extreme price movement within a short time frame.
- Exchanges like NYSE or NASDAQ initiate this halt when they detect excessive volatility.
This halt prevents the stock from moving too wildly.

Be aware that these pauses usually last 5-10 minutes.
They allow the market time to cool down and thus help avoid erratic trading.

Regulatory halts are imposed by regulatory bodies such as the Securities and Exchange Commission (SEC).
These halts are related to concerns over:

Insider trading,
Market manipulation, and
Other regulatory violations.

A regulatory halt is implemented while investigations are conducted or if the company needs to provide accurate disclosures.
Such halts remain in effect until the regulatory issue is resolved.
During this time, trading cannot resume until the investigation is completed.

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Impact of Circuit Breakers and Halts on Traders

Circuit breakers and trading halts have significant effects on trading strategies, especially for those who rely on short-term price movements. These mechanisms are designed to stabilize markets, but they also create challenges and opportunities for different types of traders. Let’s explore their impact in detail.

Challenges for Day Traders

Opportunities for Swing Traders and Long-term Investors

Day traders make quick trades within a single market session.
They are often the most affected by sudden circuit breakers or trading halts.
Since they rely on rapid price movements to make profits, an unexpected halt can leave them stuck in a position without the ability to exit or adjust their strategy.
If a halt is triggered during high volatility, traders can experience sharp price changes when trading resumes.
This increases their risk exposure.

Swing traders enter positions and hold them for days or weeks, and long-term investors usually maintain a long investment horizon (more than five years).
During a halt, these traders can use the time to assess broader market conditions.
Circuit breakers and halts provide them with an opportunity to gather:

More information,
Review market trends, and
Make more informed decisions when trading resumes.

Unlike day traders, their strategies are less dependent on minute-by-minute fluctuations.
Thus, they may even benefit from reduced volatility once the market reopens.

Use the Latest Trading Tools to Your Advantage

Do you wish to adapt better during circuit breakers or trading halts? You should definitely use our advanced market analysis tool, Bookmap, and its modern features like liquidity tracking and heatmaps. They can help you visualize market activity and order flow in real time. Also, these tools enable traders to monitor how buy and sell orders are positioned. This information helps to better anticipate market direction once trading resumes. By using these tools, traders can:

Make quicker adjustments,

Manage risk better, and

React faster when trading halts are lifted.

How to Respond to Trading Halts and Circuit Breakers?

Traders must be prepared for sudden market pauses caused by trading halts and circuit breakers. While these events can be disruptive, you maintain composure by adopting the right strategies. Let’s see how:

Prepare for Volatility	Risk Management	Avoid Emotional Trading
One of the best ways to handle market pauses is by staying prepared for volatility. Use historical data and market patterns to anticipate periods where circuit breakers might be triggered. Some common instances are during earnings seasons or economic announcements. Stay informed about the conditions that may lead to heightened market movements. This allows you to react quickly when a halt or breaker is triggered. Keep watching key market signals and news that could drive sudden shifts. Adjust your positions in advance.	To protect yourself, always use stop-loss orders. These orders automatically exit a position if the stock price hits a predetermined level. This ensures you don’t incur significant losses in case of an unexpected halt or rapid price movement when the market reopens. Additionally, avoid over-leveraging your trades during volatile periods. That’s because excessive leverage magnifies losses if prices shift unfavorably after a pause.	When a trading halt or circuit breaker is triggered, it’s easy to get caught up in the emotional response to rapidly changing news. However, it’s important to use the pause to reassess the situation objectively. Take the time to gather information. Review market trends and consider the impacts of the news that led to the halt. Avoid rushed decisions based on fear or excitement. Instead, rely on your research and analysis to guide your next move. Be calm and rational during market pauses.

Conclusion

By understanding circuit breakers and trading halts, you can protect your portfolio and maintain control during volatile market periods. Please note that these mechanisms act as safety measures. They slow down rapid market declines. This gives you time to reassess your strategies and avoid making decisions driven by panic. Significant percentage drops in major indexes trigger circuit breakers. On the other hand, trading halts apply to individual stocks. Specific events like news or regulatory concerns often cause them.

Both tools provide stability during unpredictable times. By being aware of how these mechanisms work, traders can better mitigate their risk and avoid getting caught off guard during market pauses. Also, it is important to stay calm during these events and use the time wisely to gather information. Review trends and plan your next moves thoughtfully.

Furthermore, to stay prepared, traders can also use our real-time market analysis tool, Bookmap. It allows you to track liquidity and offers heatmaps to monitor market conditions closely. By using it, you can stay informed during halts and circuit breaker events. This helps you quickly adjust your strategy once trading resumes again.

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