What are Upper Circuit and Lower Circuit?

It’s a known fact that stock markets are volatile in nature. Sudden price fluctuations have often led to investors suffering major losses.

To safeguard an investor’s interest, SEBI (Securities and Exchange Board of India) introduced circuits (upper and lower) that sets the maximum & minimum price levels to determine stock fluctuations within a day. As an investor, you must remember that the price of a stock cannot rise beyond its upper circuit in a single trading session.

A stock may hit the lower circuit when there is sell pressure with a negligent number of buyers. Lower circuits are calculated based on the closing price of the previous day and it may vary from stock to stock.

The maximum price a stock can reach on a given trading day is called the “upper circuit” and a minimum price that a stock can hit on a particular trading day is known as the “lower circuit”.

Upper and lower circuits for stocks

Stock exchanges set up a price band every day that’s based on the last traded price of the stock. The purpose of doing this is to protect investors from extreme single-day price fluctuations (hike & drop). Upper and lower circuits (as described in the above paragraph) in stock markets are done purely to protect them from the drastic volatility of the stock markets.

Upper and lower circuits for indices

Circuits aren’t necessarily used for only individual stocks, but they can also be implemented for an index. Hence, when an index dips significantly, the system of circuit breaker raises a red flag.

When this occurs, trading gets halted in both the equity and derivative markets in India. This halt can last from a few minutes to the remaining of the trading day. It depends on the percentage of the downfall in the index.

Five essential facts related to the upper and lower circuit

  • The maximum permissible limit for stocks is calculated based on the previous day’s closing price on exchanges.
  • Circuit filters can be found on the stock exchange’s website.
  • Upper circuits refer to the higher demand for shares than supply, whereas lower circuits refer to a higher supply of shares than demand.
  • In India, SEBI is the sole decider of circuit filters.
  • There are only buyers and no sellers when a stock hits its upper circuit. Likewise, there are only sellers and no buyers when a stock hits its lower circuit.

How will you use price bands and circuits on stocks to your advantage?

The price bands are set by the NSE and the BSE on all securities. Most investors, (especially retail) tend to buy stocks in the mid and small cap space. Such stocks are susceptible to wild fluctuations, either way. Circuit filters help these small investors by providing protection against big losses. In case you’ve already invested in a stock, it’s advisable that you exit when you notice the circuit level advancing. Mild volatility generally also corresponds to low earning potential.

Conclusion

The primary reason for circuit breakers being put in place is to protect investors from undue speculation and volatility. Ideally, in a situation when there’s a sudden change in stock’s demand, its price may hit the upper and lower circuit. However, in certain cases, market manipulators can try & influence the demand and supply for a stock. As an investor, kindly consider the circuit of a stock while making predictions on your price movement. Be careful not to solely base your trading on stocks hitting their upper or lower circuits!

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