How a Circuit Filter Prevents a Burnout
NSE suspended trading for 15 minutes on October 5 after its benchmark Nifty index fell 15% following punching errors worth 650 crore by a dealer at domestic brokerage Emkay Global. Trading halted after a lower circuit breaker kicked in. Apart from the brokerage, which was the worst hit, those who traded without stop losses were also affected. The situation could have been worse but for the filter. Ram Sahgal explains how does the circuit-filter mechanism works:
WHAT IS A CIRCUIT FILTER?
It is a regulator prescribed price limit on stock indices. It sets a limit on the extent to which an index such as Nifty or Sensex can fluctuate in a day. The filter, followed by a cooling-off period, kicks in once an index rises or falls by 10%, 15% and 20%. For instance, if a circuit limit of 10% is hit before 1’o clock in the noon, trading automatically stops and resumes after an hour. In case of a 20% movement of the index, trading is halted for the remainder of the day.
WHAT’S ITS PURPOSE?
A filter or breaker aims to limit the spread of marketwide panic by giving participants time to gather their wits. The moment a circuit filter is triggered on the cash segment, trading comes to an automatic halt. In the case of index futures, trading does not halt automatically but has to be stopped after trading on the cash segment ceases.
HOW ARE FILTER PERCENTAGES SET?
The filter percentages are calculated on the closing index value of the previous quarter. In the case of Nifty, for the October-December quarter, the daily filter is set based on the index closing on the last trading day of the September quarter (which was 5700 points on September 28). So to calculate the 10% filter percentage for Thursday (October 11), add and subtract 570 (10% of 5700) to Nifty’s Wednesday’s closing of 5620 (5652 +/- 570) to get 6,222 as the upper limit and 5082 as the lower limit.
WHY DID NSE RESUME TRADING IN 15 MINUTES ON OCTOBER 5?
Friday’s trades were not the result of panic but of human error. Once the reason for the Nifty’s fall was identified, the system did not accept any fresh orders. Only the existing ones had to be matched to prevent trade integrity issues from cropping up. Trading resumed normally with Nifty having recovered shortly after the 15.5% fall.
DOES A CIRCUIT FILTER APPLY TO SHARES?
Circuit breakers are only for indices. The regulator has a ‘price band’ for shares in the cash segment and an 'operating range' for the futuresand-options segment. Individual stocks have a price band of 20%; that is, a stock cannot fluctuate more than 20% from its previous day’s closing. An exchange is allowed to reduce this band to 10%. F&O stocks have operating ranges, again at 20%; that is, an order cannot be placed by a trader above or below the 20% limit. The absence of a price band caused certain frontline Nifty stocks to drop below 20% on October 5 because of Emkay’s erroneous trades.
WAS TRADING EVER HALTED FOR THE WHOLE SESSION?
Yes. On May 18, 2009, after both Nifty and Sensex hit the 20% upper circuit following the UPA's victory in the general elections.
WHAT IS A CIRCUIT FILTER?
It is a regulator prescribed price limit on stock indices. It sets a limit on the extent to which an index such as Nifty or Sensex can fluctuate in a day. The filter, followed by a cooling-off period, kicks in once an index rises or falls by 10%, 15% and 20%. For instance, if a circuit limit of 10% is hit before 1’o clock in the noon, trading automatically stops and resumes after an hour. In case of a 20% movement of the index, trading is halted for the remainder of the day.
WHAT’S ITS PURPOSE?
A filter or breaker aims to limit the spread of marketwide panic by giving participants time to gather their wits. The moment a circuit filter is triggered on the cash segment, trading comes to an automatic halt. In the case of index futures, trading does not halt automatically but has to be stopped after trading on the cash segment ceases.
HOW ARE FILTER PERCENTAGES SET?
The filter percentages are calculated on the closing index value of the previous quarter. In the case of Nifty, for the October-December quarter, the daily filter is set based on the index closing on the last trading day of the September quarter (which was 5700 points on September 28). So to calculate the 10% filter percentage for Thursday (October 11), add and subtract 570 (10% of 5700) to Nifty’s Wednesday’s closing of 5620 (5652 +/- 570) to get 6,222 as the upper limit and 5082 as the lower limit.
WHY DID NSE RESUME TRADING IN 15 MINUTES ON OCTOBER 5?
Friday’s trades were not the result of panic but of human error. Once the reason for the Nifty’s fall was identified, the system did not accept any fresh orders. Only the existing ones had to be matched to prevent trade integrity issues from cropping up. Trading resumed normally with Nifty having recovered shortly after the 15.5% fall.
DOES A CIRCUIT FILTER APPLY TO SHARES?
Circuit breakers are only for indices. The regulator has a ‘price band’ for shares in the cash segment and an 'operating range' for the futuresand-options segment. Individual stocks have a price band of 20%; that is, a stock cannot fluctuate more than 20% from its previous day’s closing. An exchange is allowed to reduce this band to 10%. F&O stocks have operating ranges, again at 20%; that is, an order cannot be placed by a trader above or below the 20% limit. The absence of a price band caused certain frontline Nifty stocks to drop below 20% on October 5 because of Emkay’s erroneous trades.
WAS TRADING EVER HALTED FOR THE WHOLE SESSION?
Yes. On May 18, 2009, after both Nifty and Sensex hit the 20% upper circuit following the UPA's victory in the general elections.
