What are the Upper Circuit and Lower Circuit in the Share Market?

The terms upper and lower circuits are too common in the share market today. In the Indian share market, the upper and lower circuits act as mechanisms employed to regulate or manage extreme movements in the prices of company stock.  

If you are a trader looking to get a firm grasp of the stock market, this article dives deep into upper circuit stocks, lower circuit stocks, how the circuits work, and more. 

What is the upper circuit and how does it work? 

Concerning the Indian stock markets, the upper circuit, or upper circuit stocks, refer to a company stock’s maximum price that can be realised in any given session of trading. The upper circuit is formed and fixed by the stock exchange in question. The stock exchange does this to mitigate or lessen the drastic volatility of prices of stocks, thereby safeguarding investors from unexpected shifts in prices. 

You could say that upper circuit stocks are those whose maximum price in any trading session is predetermined. If investors have a clear idea about the upper circuit, they can grasp market sentiment. Consequently, investors can make informed decisions about their stock investments, particularly in a bullish market environment. 

What is the lower circuit and how does it work? 

Simply put, the lower circuit, or the lower price band, in the share market, refers to the most minimal level that a stock price can drop within a given trading session. 

In any trading session, the occurrence of the lowest band, or when a specific company stock hits its lowest price, means that trading of that stock will be suspended temporarily. This is done to prevent any further fall in the stock’s price, protecting investors from major losses. 

Upper and Lower Circuits for Stocks

When investors know a share with an upper circuit level or lower circuit level is going to be part of a trading session, they can likely make decisions to avoid risk. Once traders know what these limits are, they can control their trading positions and activities and potentially make profitable trades. 

But what are these limits in terms of the upper circuit and lower circuit that exchanges have fixed for stocks in particular? Let’s take a look. Certain stocks are grouped into particular categories by exchanges, informing investors whether they are upper circuit stocks or lower circuit stocks, or both. Consequently, stocks that are listed in A, B, T, and TS groups have upper circuit and lower circuit limits. These limits range from 2% to 5% and these constitute stocks that are frequently traded on exchanges. 

It is also important to note that some stocks have higher upper circuit price limits and lower circuit price limits than others. These are categorised under group S with limits that range from 10% to 20%. These stocks tend to be more prone to speculative trading than other stocks. 

If you want to get a hang of how a share with an upper circuit limit and a lower circuit limit works, you can read the example below:

Let us say that a stock holds a circuit limit of 10% with its closing price on the previous day at ₹2,000. From this, the stock’s upper circuit limit would be ₹2,200 for the present trading session (adding 10% of ₹2,000). Conversely, the lower circuit limit for the same stock will be ₹1,800 (less by 10%). Therefore, you may have gauged that circuit limits are fixed based on the stock’s previous day’s closing price and calculated by a set percentage of that price. So, in stock trading, the upper circuit limit and lower circuit limit can change every day. 

Upper and Lower Circuits for Indices 

In general, stocks have a single set limit regarding circuit limit prices. However, market indices have three upper circuit and lower circuit limit calculations. They are mentioned below:

• First Circuit Limit: This is calculated as 10% of the said stock’s closing price on the previous day.
• Second Circuit Limit: This is calculated as 15% of the said stock’s closing price on the previous day.
• Third Circuit Limit: This is calculated as 20% of the said stock’s closing price on the previous day.

In case the price of a lower circuit stock or an upper circuit stock has been crossed, trading is stopped on a temporary basis. This trading break may last for 15 minutes to the remainder of the trading session, based on the time of the trading day. 

What drives the upper/lower circuits? 

The upper and lower circuit price limits for the present trading day operate and are calculated based on the said stock’s closing price on the previous day. Simply put, in the event of any change in the previous day’s closing price, the change will be reflected in the current session’s upper circuit stocks and lower circuit stocks. 

Although the previous session’s stock closing price determines the subsequent circuit price limit, several factors indirectly affect circuit limits and directly affect the closing prices of stocks. These factors include interest rate changes, company performance, political and economic factors, among other variables like modifications in trade agreements, mergers, acquisitions, and company insolvency, and investor confidence. 

Five Essential Facts Related to the Upper and Lower Circuit 

Traders need to have a solid knowledge of upper and lower circuit limits as these criteria have a bearing on their trading strategies and decisions. Essentially, they can mitigate or heighten your risk, and this is imperative to account for while you are trading. Hence, here are five important facts you should consider:

• The circuit limits serve the purpose of security measures for the interests of investors, preventing panic buying or selling in times of critical market volatility.
• Upper circuit limits (upper circuit stocks) and lower circuit limits (lower circuit stocks) for indices and stocks are generated and regularly updated before trading sessions. You can find this information on the relevant exchange website. 
• In case a stock crosses its upper circuit limit, investors are unable to buy shares as there will be no sellers. If stocks cross their lower circuit limit, investors are unable to sell shares as no one will buy them.
• In case a circuit limit breach takes place, and trading is stopped for the remainder of the trading day, every intraday order is automatically changed to a delivery order by respective brokers. 
• In the realm of stock trading, circuit limits may be fixed, but do not stay that way. They are adjusted on a periodic basis according to certain factors such as trading volumes, market conditions, and levels of stock volatility. 

How to Use Circuits or Price Bands on Stocks to Your Advantage 

Circuits or price bands on stocks can be used to your benefit in key ways, as highlighted below: 

• Plan Investments: Before investors invest in any stock, they must know the circuit limit set for it. This aids in planning strategies, mainly for those who are interested in short-term returns.
• Minimise Losses with Circuit Filters: You can reduce your losses by using circuit filters. In the event that a stock’s price drops sharply, touching the lower circuit price, you may consider exiting the stock and cutting your losses.
• Seek Stock with High Circuit Price Limits: Upper circuit stocks with high limits may work to your advantage as they can potentially reap higher gains. Nonetheless, it is essential to research a stock before you invest.
• Do Not Rely Exclusively on Circuit Limits: Like any other aspects of stock trading, circuit limits are without their flaws and cannot be solely depended on for returns. Stock prices are impacted by many factors such as geopolitical factors, economic conditions, and company performance, among others.

Conclusion  

In keeping with compliance regulations to protect investors’ interests, stock exchanges employ circuit limits to mitigate stock investment risk due to market uncertainty. By grasping the crux of upper and lower circuit price limits, investors can go a long way in reducing risk in their investment by gaining control of their trading positions. If used properly, circuit limits can prove profitable for traders who keep up with market trends and factors that affect circuit limits.