Understanding upper circuit and lower circuit in Share Market

You Need To Understand The Upper Circuit And Lower Circuit In The Stock Market: Here’s Why

Decoding upper and lower circuits is crucial while investing in the share market as it helps investors understand the price limits within which a stock can fluctuate, enabling them to make informed decisions and manage their trading strategies effectively. 

These terms define the price limits imposed on stocks during trading sessions. An upper circuit represents the maximum permissible limit at which a stock can rise in a single trading session, while the lower circuit is the lowest limit to which a stock's price can drop. These circuits are defined by stock exchanges, such as the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) in India.

By having a clear understanding of these terms, you can gain insights into the potential volatility and trading restrictions associated with specific stocks. This post will help you understand what an upper circuit and a lower circuit in the share market are and how they impact trading strategies. 

The Introduction of Upper and Lower Circuits 

The story dates back to 2001 when the Securities and Exchange Board of India (SEBI) implemented the concept of circuit filters to regulate and control price movements in the stock market, particularly for individual stocks. 

 Circuit filters help curb excessive volatility and price manipulation in the share market by imposing upper and lower price limits. These limits prevent stocks from experiencing sudden and drastic price movements, ensuring a more stable trading environment and reducing the potential for manipulative activities. By restricting extreme price fluctuations, circuit filters promote fair and orderly trading, enhancing market integrity and investor confidence.

Over the years, SEBI has periodically reviewed and revised these circuit filters to align them better with market conditions and strike a balance between allowing price discovery and preventing extreme price movements. 

Upper Circuit in the Stock Market 

An upper circuit is a price limit set by the stock exchanges beyond which a stock's price cannot rise during a single trading session. When a stock hits the upper circuit, trading in that particular stock is temporarily suspended. Upper circuit limits prevent excessive price volatility and manipulation in the stock market by restricting the maximum price at which a stock can be traded, curbing sudden price spikes, and ensuring stability.

The reasons stocks hit upper circuits include - 

• Positive market sentiment: This can be driven by favourable news, positive earnings reports, corporate announcements, or market speculation, causing a significant increase in demand for a particular stock.
• Limited Supply: An upper circuit occurs when the supply of a stock is limited in the market. If there is a scarcity of sellers willing to offer the stock at a lower price, it creates a situation where buyers are willing to pay higher prices, driving the stock's price to the upper circuit limit.

 Market manipulation and liquidity constraints can also lead to this. Sometimes, even a marginal increase in demand propels the stock's price toward the upper circuit. 

Lower Circuit in the Stock Market

A lower circuit in the stock market represents the minimum price limit at which a stock is allowed to trade during a particular trading session. These circuits are calculated based on the previous day's closing price and can vary from stock to stock.

Defining a lower circuit is important as it sets a price limit below which a stock cannot be traded, preventing excessive price declines and safeguarding against potential market manipulation and panic selling.

Here are some common reasons why stocks hit lower circuits -

• Negative Market Sentiment: Stocks can hit lower circuits when there is negative news or events that negatively impact investor sentiment. This can include poor earnings reports, regulatory actions, or adverse macroeconomic factors. News related to this can trigger a sell-off, causing the stock's price to decline and hit the lower circuit rapidly.
• Market Decline: During periods of market-wide decline or a bearish trend in the market, stocks across various sectors may experience downward pressure. If the selling pressure is intense and widespread, it can lead to stocks hitting lower circuits as investors rush to sell their holdings.
• Company-Specific Issues: Stocks can hit lower circuits due to a company’s poor financial performance, management concerns, or legal disputes. These factors erode investor confidence, leading to significant selling and a decline in the stock's price.

Also, liquidity constraints for stocks with low trading volumes are more susceptible to hitting lower circuits. If there is a lack of buyers willing to purchase the stock at higher prices, it can result in a scenario where sellers are forced to lower their asking prices, pushing the stock's price to the lower circuit.

Note: During periods of intense market volatility, where significant upward and downward movements occur, trading can be temporarily halted by SEBI, leading to stocks hitting either the upper or lower circuit limits to safeguard investors/traders. This is called a circuit breaker. 

Conclusion

Understanding upper and lower circuits in the share market is crucial for investors looking to navigate price movements and make informed decisions. SEBI's regulations play a vital role in maintaining market stability and safeguarding investor interests. To empower investors, platforms like the Axis Direct 3-IN-1 Account provide comprehensive tools, market data, research, and personal assistance, all in one place, ensuring a seamless trading experience while prioritizing investor interests.