Skip to main content

Emergency Stop: Circuit Breakers Explained

red fire alarm station attached on brick wall

Recently, the markets have been incredibly volatile. With stock prices moving violently up and down (mostly down) without pause. On any given day, a 10% change in either direction.

This is a time of great uncertainty and investors hate uncertainty. Many will panic and sell, retreating to the safety of cash. With more sellers than buyers, there's a downward pressure on prices. When prices fall, more investors panic and start selling too.

This vicious cycle can lead to disaster. To prevent this, or at least to soften the landing, regulators have controls in place.

Taking A Break

A circuit breaker is a temporary pause in trading, enforced during wild market conditions. The idea is to give traders a chance to take a step back so they can make better, more informed decisions.

Circuit breakers apply to broad market indices as well as individual securities.

Market Level Circuit Breakers

Circuit breakers are trigged at a predetermined levels. The S&P 500 for example has three levels: price movements of 7%, 13%, and 20%.

Level 1: When the index moves 7%, trading is halted for 15 minutes.

Level 2: When movement reaches 13%, trading is halted for another 15 minutes.

Level 3: When movement reaches 20%, trading is done for the day. We've seen enough! 

Circuit Breakers For Individual Securities

For established companies like Amazon and Google, when movements reach 5% trading will pause for 5 minutes. The threshold is increased to 10% for the first and last 15 minutes of the trading day as this is when markets move most.

For riskier, less established companies (such as stocks less than $3), the movement allowances are much wider.

Do They Work?

Some critics have argued that circuit breakers can create more volatility. Artificially pausing markets introduces a reduction in liquidity and limits price discovery. It may also encourage additional buying and selling as traders try to avoid getting stuck in unfavourable positions when a halt is near.

There's not enough evidence to draw a definitive conclusion. Ultimately, the idea is sound. Don't get caught up in the hysteria, take a breather and make decisions from a rational place. If you're investing for the long term, with a risk-appropriate portfolio, short-term volatility doesn't matter. The news can be scary, but ultimately it's just noise. Stay healthy out there.


Popular posts from this blog

The Art of Giving Feedback

Constructive feedback is an awkward affair. You don't want hurt feelings, but recognize the importance of honesty. You've tried the classic "hoping things will get better on its own" and unfortunately it hasn't played out. When giving feedback, here are a few things that I try to keep it mind. Start with empathy. Step into their shoes and understand their story. If you don't know, ask. Be genuinely curious. Feedback is a dynamic affair. Shared communication with a shared goal towards progress. Take the emotion out of it. Focus on the situation, not the person. Focusing on the person adds unnecessary weight to an already emotionally-bloated event.  Be specific. Give clear examples. Vague feedback equals dismissed feedback.  Doing above won't de-awkward things fully, but it will dampen it and increase the chance of better outcomes. 

Bias For Clarity

Bias for action. Gets things done. Go-getter. Traits companies big and small look for. And for good reason, you're being hired to do things! However, action is a secondary step that often overshadows the primary step, direction.   Clear direction is the foundation that enables our actions to takeoff. Without it, we're stuck in the mud.  Striving for clarity is an underrated skill. Having the courage to ask ( seemingly ) obvious questions, and to check in, making sure we're all on the same page. "O bvious " questions are a low risk, high reward way to add value. At worst, you'll add confidence to our actions. At best, you discover a misalignment that saves us from a dead-end.  The more people, the more clear we need to be. The bigger the initiative, the bigger the risk of reaching the finish line, only to realize expectations were off.  Success is always uncertain. But we can be certain about what we want and what everyone's job is. Things that can be clea

Negative Feedback, Positive Lessons

In the battle against plastic bags, a five-cent tax was shown to be much more successful at deterring usage than a five-cent credit for bringing your own bags. Carrots satisfy but sticks sting, and they sting hard. So we default to the less painful choice of avoiding loss. Loss aversion impacts the way we process information. A 2019 study  invited participants to learn through a series of multiple choice questions. Each question only had two options to choose from. Whether guessing correctly or not, they would still learn the right answer.  Despite the identical learning opportunity, participants were much more successful at recalling the answers they guessed correctly than those they got wrong.  "You're right!" feels good. We savour the moment, analyzing every detail.  "You're wrong!" stings. We want to quickly forget, dismiss, and move on.  When we succumb to loss aversion, we miss opportunities to learn. Failure is part of the process. We'll experie