With the changing and developing world, more and more young investors are moving towards the stock market and are looking forward to understand and invest in it. As the young ones try to explore the market, they may hear new terms everyday and it might get a little confusing to comprehend all of them at once. Through this article, we try to explain a very significant concept of the investing world called circuit and its two types.
When a stock makes a strong move in either way – up or down – or hits its maximum allowable tradeable price level for the day, it is said to have struck the circuit.
The irregular price movement might occasionally be quite dramatic as a result of emotional reactions to the market. These abrupt changes might cause the price to sharply increase or dangerously decrease.
Extreme volatility brought on by the quick increase or fall leads to capital loss and other market imbalances. To counteract market volatility caused by an excessively emotional reaction to stock prices, circuit breakers were placed.
What are upper and lower circuits?
The stock exchanges put up a price range each day based on the stock's most recent traded price to safeguard investors from a significant single-day reactionary share price decline or boost.
The upper circuit is the highest point beyond which a stock's price or an index's value cannot increase in value in one day. Stocks that have a lot of buyers but few sellers might reach the upper circuit. Upper circuits are computed using the closing price from the previous day.
In a single trading session, a stock's price cannot increase over its upper circuit. However, if some start selling, the prices can fall.
The lower circuit is the lowest point that a stock's price or an index's value might drop. Stocks that many people want to sell but that hardly anybody is purchasing might fall in price.
Lower circuits are similarly computed using the closing price from the previous day, however they may vary from stock to stock. The price of a company might not drop below its lower circuit in a single trading session, but if investors start buying the stock, the price might climb.
How do stocks hit upper or lower circuits?
Stock prices are solely governed by the forces of supply and demand that the market freely generates. A stock's price will increase if demand outpaces supply, and it will decrease in value as demand decreases.
Several factors might cause a certain stock to hit a circuit. For instance, if there is positive sign, there may be strong demand for the company's shares, which might cause the stock to rise, and vice versa.
Therefore, the stock enters an upper circuit when there is a larger demand than supply for shares, and a lower circuit when there is a higher supply than demand.
The Securities Exchange Board of India, or SEBI, the market regulator, determines the circuit filters, which are then updated in response to market volatility or any unusual activity in certain counters.
In addition to this, the circuit filters undergo frequent revisions based on market liquidity. Circuit filters are increased for companies with strong liquidity and decreased for equities with weak liquidity. These cyclical modifications are used to safeguard investors' interest in unpopular stocks.