Indian markets witnessed their second circuit breaker in a month on Monday as the benchmark Sensex tanked 10 per cent within the first hour of trading. Before the recent instances, circuit breakers were triggered at the peak of the previous global financial crisis.
This is second time since January 21, 2008 and sixth time in the past two decades that trading in India has been frozen because of indices hitting the lower circuit. Here are some of the most important things investors should know about a circuit breaker
What is a circuit breaker?
It is a trading curb imposed by stock exchanges whenever there is heightened volatility. Circuit breakers became important tools for exchanges and global market regulators to cool-off since the 1987 Wall Street crash. Whenever a stock hits the circuit breaker, trading is shut down for some time in that counter. Then there are index circuit breakers that get triggered if benchmark indices rise or fall significantly. When the benchmark index hits the circuit breaker, trading is halted for a fixed time across the market. This time is called the cooling-off period and it is aimed at calming the panic in the market.
Are circuit breakers always signs of bad news?
A circuit filter can be triggered even if a stock or an index is gaining too much, too quickly. For instance, in 2009 Indian markets witnessed circuit breakers due to a sharp rally of over 10 per cent in a single session.
When is a circuit breaker triggered?
In the Indian markets, there are three different circuit breakers that get triggered.
The first one is when the index rises or falls 10 per cent from its previous close.
The second one is triggered at 15 per cent rise or fall, while the third one is activated at 20 per cent rise or fall. The mandatory cooling of period varies, depending on which circuit filter has been hit. It could be as low as 15 minutes if the 10 per cent circuit is triggered. On the other hand if the market hits say the 20 per cent circuit, trading will be halted for the rest of the session.
Which are the other factors that impact the cooling-off period?
Apart from which circuit has been triggered, the quantum of the cooling off period applicable also depends on at what time the circuit was triggered.
If the market breaks the 10 per cent circuit before 1 pm during any session, trading will be halted for 45 minutes, like what was witnessed on Monday.
If the same circuit is hit between 1 pm and 2:30 pm, the halt will only be for 15 minutes and if is triggered after 2:30 pm, there will be no halt in trading.
If the 15 per cent circuit is hit any time after that, markets are closed for the rest of the session. Whenever the market hits the 20 per cent circuit, trading gets automatically closed for the rest of the session.
Novel coronavirus has tested the might of the world powers. The world is feeling the heat of the pandemic on multiple fronts. It is scampering to rescue humankind from grip of Covid-19 and facing an uphill task of preventing an economic collapse.
While concrete data of loss in businesses and of employment come months later, the sentiment in the markets across the world is gloomy. This is reflected in the frequent crashes in the share markets in all parts of the world.
This is the biggest economic crisis in the world since 2008. Some people are already calling it the biggest since 1929-30 economic recession. Unemployment has risen in all affected countries. In the US, data point to biggest jump in people enrolling for unemployment benefits. In India, the worries are similar but there are no concrete data yet to support.
The only data reflection is share market. The Sensex is racing to go back to the pre-Modi government level in India. On Monday, the Sensex closed below 26,000-mark. It recorded the biggest-ever single-day fall of 3,934 points closing at 25,981. The Sensex had crossed the 25,000-mark barrier for the first time on the day the Modi government was voted to power in 2014 – on the day of counting.
In the past one month, the Sensex has broken record of biggest single-day fall five times. The current season of coronavirus-induced volatility in the share market has wiped off Rs 52 lakh crore of the investors. This is a picture in contrast from the high point on January 13 this year when the Sensex was racing towards 42,000-mark having crossed 41,952.
The template is same for all the major economies. In the US, the Securities and Exchange Commission has enforced four circuit breakers in the Month of March. It is a safeguard that pauses trading for 15 minutes hoping the market will calm.
Circuit breaker is a tool created in the US after 1987 market crash in which the Dow plunged nearly 23 per cent. Before being enforced four times this month, it had been used only once – during 1997 crash.
Similar panic has been seen in the UK, Germany, France and all Asian markets except China, the source country for novel coronavirus pandemic.
China’s share market benchmark, Shanghai Composite Index (SCE) was at 2,915 on December 12. It was just before the news of novel coronavirus outbreak in China started surfacing. It reached the high point of 3,115 on January 13 and slipped marginally to 3,095 on January 20 when China for the first time officially admitted novel coronavirus outbreak with pressure building from within and outside the country.
On January 23, when it closed for Chinese new year holidays, it was trading at 2,976. It saw a major fall on February 3 when it opened after holidays were extended in the wake of novel coronavirus outbreak. Trading was closed before time at 2,746 point.
Interestingly, China a day earlier had announced infusing liquidity worth of $173 billion into its markets. This kept the sentiments in Chinese markets in good spirit despite increasing cases of novel coronavirus in China through February. The result was the losses in Chinese stock markets were not as severe as outside.
The Shanghai Composite on Tuesday stood at 2,722 – not much below the pre-Covid-19 phase. The world has lost hundreds of billions during this phase.
While Indian rupee has been fragile under the impact of novel coronavirus, Chinese yuan or renminbi has remained relatively strong against the US dollar. In the official basket of currencies, yuan has, in fact, climbed more than 4.75 per cent this year, which has been under the shadow of coronavirus pandemic.
According to China’s State Administration of Foreign Exchange, the average daily difference in the US and Chinese 10-year government bond yield is 172 basis points. This means the Chinese assets offers far more attractive returns for an investor.
Simply put, China seems to be the financially least affected of all countries rocked by novel coronavirus pandemic despite weeks of lockdown. Share market data may not be the ultimate measure of economic impact of Covid-19. However, China is not known to put out adverse data in public. So, true scale of damage may not be known for years.
There is another explanation, however, for less volatility seen in China’s share markets. Of the tradable share market capitalization in China, foreign capital accounts for less than four per cent. The rest is in the hands of the Chinese government, directly or indirectly.
The curve of Chinese stock exchange indices is also curious in the sense that China’s was one of the worst-performing share markets before Covid-19 changed the world market outlook.
A Dedicated Business Conference on Option Greeks Trading by Jainam Share Consultant along with Greeksoft Technologies.