Through the Lens of Circuit Breakers: Why does the Stock Market Hit Pause?

Imagine this. Monday morning, June 23, 2025. This weekend the United States bombed three nuclear sites in Iran with bunker-busting bombs. President Trump said the sites had been “totally obliterated.” Iran promised revenge and authorized the closing of the Strait of Hormuz, one of the world’s most important oil chokepoints. You open your trading app, and the market is already bleeding.

BSE Sensex fell intraday by 931 points. The Nifty 50 was down 287 points. Oil prices rocketed. The rupee faltered. And on trading desks and WhatsApp groups alike, one question was being passed around: how far can this go down before the market just stops?

When does the market stop, and who decides? This question hit right at one of the most important, yet least understood, mechanisms in financial markets: The circuit breaker. It’s a tool that generally operates in the background, unnoticed, until the tensions in geopolitics start to rise and then the panic begins to seep through the trading floors.

For the seasoned trader or the new investor, circuit breakers are the invisible guardrails that separate a bad day from a market catastrophe. The answers range from human psychology to market design and the architecture of financial systems.

What exactly is a Circuit Breaker?

If the market index like Nifty 50 or Sensex falls by a certain percentage in a trading day (or sometimes even rises), then the trading is automatically stopped for a specified time. The purpose of this pause is to:

• Cool down panic: Give investors the space to think rationally rather than react emotionally.

• Share information: Make news available to all participants.

• Re-establish order: Allow buyers and sellers to reassess before prices go further.

• Prevent failure: Don’t let a bad day become a catastrophic free fall.

So, in effect, circuit breakers are the market’s automatic emergency brake. Not a crash, not a failure. Just a deliberate, rule-bound pause.

Where Did It All Start?

To understand circuit breakers, we must go back to October 19, 1987, a day known as Black Monday. The Dow Jones Industrial Average fell 22.6% in one day, the biggest single-day crash in stock market history, and it happened with shocking speed. No guard rails, no delay but just free fall. Panic bred panic and the market had no brake.

“The market had lost its ability to self-correct. Prices were no longer reflecting value — they were reflecting fear. — Brady Commission Report, 1988”

The fallout was a time for some serious soul searching. President Reagan created the Brady Commission, which recommended that stock, futures and options markets coordinate trading halts to reduce panic selling. And thus, circuit breakers were born, formally implemented by the NYSE in 1988.

They’ve been honed ever since, with each major crisis teaching us something new about how fear flows through financial markets.

How Does the System Work in India?

India has a well-defined circuit breaker mechanism introduced by SEBI (Securities and Exchange Board of India) in 2001. It functions on two levels:

Index-based Market-wide Circuit Breakers

It bring an overall trading halt in all equity and equity derivatives markets nationwide and is triggered if BSE Sensex or NSE Nifty moves by a certain percentage:

10% Breach (Before 1 PM): Trading halted for 45 minutes followed by a 15-minute pre-open call auction.

Pause of 45 min for 10 % breach when turned on before 1 PM.

15% Breach (Before 1 PM): Trading halted for 1 hr 45 min, followed by a 15-minute pre-open auction.

20% Breach: Trading suspended for remainder of day.

Individual Scrip-Level Price Bands

Individual stocks (excluding F&O) also have price bands which are usually up or down by 2%, 5%, 10% or 20% beyond which a stock cannot trade in a single day. Additionally, price bands are also applicable on individual scripts (on which no derivative products are available) which are a part of Index Derivatives. So if a stock hits its upper or lower limit circuit, buy orders can be placed at the exact price level and they pool up in the order book until a seller appears.

That’s why you may see a stock marked as “Lower Circuit” or “Upper Circuit” on your trading app, and no trades taking place. The system has set a price ceiling for the day.

Does it work? Really?

For decades, researchers have debated a question: Do circuit breaker in share market actually reduce harm, or do they simply postpone it?

The honest answer is that it simply depends on the circumstances.

Why Circuit Breakers?

• Breaks the panic-driven herding behaviour

• Allows time for correct information to reach all parties involved

• Short-term extreme price dislocation mitigation

• Defends retail investors who are slower to react than algorithms

However, the following points must also be kept in mind:

• May not remove volatility, only postpone it.

• Creates liquidity risk: investors can’t get out when they need to.

• Sometimes can cause “magnet effect,” i.e., prices rush to the limit.

• Could create uncertainty during the halt itself.

One very interesting concept from research into microstructure is the “magnet effect.” It is the counterintuitive idea that a circuit breaker limit can actually pull prices toward it. But when traders see the market nearing the 10% limit, some panic and sell before the market closes, accelerating the very crash the mechanism was supposed to stop.

Takeaways

At the core, circuit breakers are an admission of something that economics took a long time to acknowledge that the markets aren’t always rational. Investors panic and algorithms can magnify those panics. And without guardrails, a temporary shock can turn into a self-fulfilling disaster. Markets are not machines, but they are made of human investors, and sometimes these investors need a little push to slow down.

As a retail investor, understanding circuit breakers is about understanding why your trades may not go through during extreme market conditions, and why that may be protecting you more than you think. To a market design enthusiast or researcher, they represent one of the most elegant and controversial interventions in financial market microstructure.

Next time the market pauses …you will see that it is not chaos. It’s the design. The market isn’t broken, it’s doing exactly what it was designed to do. Buying time, spreading the word, preventing a bad moment from turning into a catastrophe.

And that is really what market microstructure is all about.

Author: Nitika Sharma (Assistant Manager, Centre for Capacity Building, NISM)