Are you worried about a stock market crash? The good news is that there are mechanisms in place to prevent an outright stock market crash over the entire system in a single day. This is where the market’s circuit breakers kick in with a pause for trading halts.
Investors need to know that these circuit breakers will not prevent longer duration sell-offs from turning into corrections and bear markets. Still, they will prevent days like in March 2020 during the pandemic and the 20%-plus drop in the 1987 Crash from toppling the system in an instant.
While the last week felt awful, and while many of us lost our proverbial shirts in buy and hold accounts, the reality is that the market selling did not turn into panic selling that triggered the circuit breakers.
Some investors may need to know what exactly will trigger a circuit breaker. These circuit breakers have not been universal over time, but the reality is that they are very rarely tripped because of the severity needed for a one-day drop.
Still, circuit breakers were implemented after big crashes and one-day events were exacerbated because the breakers were not in place. The NYSE equities and options exchanges have procedures for coordinated cross
market trading halts if a severe market price decline reaches certain points. These Market-Wide Circuit Breakers are there for when panic selling may exhaust market liquidity. The NASDAQ also implemented its changes for Market-Wide Circuit Breakers in 2013.
LEVEL 1 CIRCUIT BREAKERS 7% – OUCH!
For a Level 1 circuit breaker to trip, the S&P 500 has to fall 7% in a single trading session. If this 7% drop is seen before 3:25 p.m. Eastern Time then trading is halted for 15 minutes. If the 7% drop occurs in the last 35 minutes of the day, then trading will continue as normal unless a Level 3 breaker is tripped
LEVEL 2 CIRCUIT BREAKERS 13% – WHOA!
A Level 2 circuit breaker is caused when the S&P 500 falls by 13% intraday. Unless this is the result of a gap-down, it means that a Level circuit breaker would have already seen a 15 minutes trading halt. If the Level 2 circuit breaker occurs before 3:25 p.m. Eastern Time then equity trading is halted for 15 minutes. If the 13% threshold does not happen until after 3:25 then equity trading will continue to the 4:00 p.m. Eastern closing bell unless a Level 3 circuit breaker is triggered.
LEVEL 3 CIRCUIT BREAKERS 20% – OH CRAP!
A Level 3 circuit breaker is tripped when the S&P 500 falls by a massive 20% in a single trading session. This is the worst sort of circuit breaker for any investor to see. If the S&P 500 plunges by 20% in a single day, regardless of the time of day, then stock trading is suspended for the rest of the trading day.
AND WHAT ABOUT FUTURES LIMIT-DOWN?
There are times outside of U.S. trading hours where S&P 500 futures can be halted for trading in a “limit down” level. This occurs if futures fall by 7% and trading is halted until traders are willing to buy contracts at the “limit down” level.
