Circuit filters are price bands imposed by the Securities Exchange Board of India (SEBI) to restrict the movement of stock prices (up or down), of listed securities. This is to curb manipulation done in share prices by operators.
Stock exchanges introduced circuit filters, as per SEBI guidelines to prevent a steep fall/rise in stock prices and to safe guard interest of investors from volatility in price.
How do they work?
When the stock price breaches a stipulated price band as decided by stock exchanges, trading in that particular stock is suspended.
For example, if you have a share price of Rs 100, and there is a circuit breaker of 5%, it will stop trading if the share price goes above Rs 105. Similarly. if the stock drops below Rs 95, the lower end circuit filter is applied and trading is suspended.
Circuits limit for stock exchanges
There are three circuit filters for indices - 10%, 15%, and 20%. These filters are applied to Sensex or Nifty whichever crosses the limit first. The trigger also depends on the time at which it occurs.
10% drift on either side
If the drift is before 1 pm – 1 hour halt
If the drift is after 1 but before 2:30 pm – half an hour halt
If the drift is after 2.30 pm – no halt
15% drift on either side
If the drift is before 1 pm – 2 hours halt
If the drift is after 1 pm but before 2 pm- 1 hour halt
If the drift is after 2 pm – no further halt
20% drift in either direction
In case of a 20% movement in either index, the trading will halt for the remainder of the day.
The circuit filters are reduced in case of illiquid scrips. The circuit filters are reduced to 10% or 5% or 2% bsed on the criteria decided by the stock exchanges.
No circuit filters are applicable on scrips in which derivative products are available and scrips which are liquid and included in indices on which derivative products are available.
However, the BSE imposes dummy circuit filters on these scrips to avoid punching errors.
Why are circuit filters needed?
In times of volatility, circuit filters are much needed. Let us give an example. Let us say there is results of a particular company and the results are a complete disaster. It is highly likely that the stock would dip more than 10 to 20 per cent. If there is a lower circuit filter of 5 per cent, you are preventing a massive erosion in the stock.
In terms of the stock index, one rarely sees circuit limits being breached. It may happen rarely as was the case when the UPA came to power for the second time with a decent number, which resulted in the filters being applied for the indices.
Exchanges review index filter for individual stocks
The Bombay Stock Exchange and the National Stock Exchange, both tend to review the performance of each circuit filter. If the stock has over a period of time, become less volatile, they could relax the circuit filter limits in a particular stock.