Why do stocks hit the lower circuit and how do sell/buy stocks, which have hit the lower circuit?

 

Market participants anticipate volatility because the stock market is notorious for it. In fact, making money off short- and long-term price changes in stocks is a key principle behind the very idea of the stock market.

However, what if this volatility exceeds the range that can be controlled, causing abnormal stock movements and unheard-of gains or losses? By putting price circuits on equities, SEBI has implemented methods to control price volatility.

Circuits prevent investors from being caught off guard by any abrupt, unexpected price changes by limiting the movement of stock price beyond a certain permitted level.

What is a lower circuit?

A lower circuit is put in place to restrict a continuous spiral down of a stock’s price beyond a predefined percentage. The lower circuit defines the lowest tradable price for a stock in a particular trading session. The stock will be ‘frozen’ at the lower circuit until the time there are no fresh buyers who come to the rescue.

When a stock hits its lower circuit, there will only be sellers and no buyers, but because the stock is already trading at the lower circuit, no more sell orders are entertained. However, buy orders will be executed without any hindrance because the lower circuit is put in place to restrict further selling, not buying.

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Why do stocks hit the lower circuit?

There may be varied reasons for stock to slump; it could be a domino effect of index-wide selling or industry-wide selling.

It could be because of a negative news development about a particular stock, like the exit of senior key management personnel, or disruption of a potential deal for the company.

Who sets the lower circuit and the circuit limit?

We just saw in the above example that the lower circuit for ADANI GREEN is set at 5%. But that’s not the case with all the stocks. The minimum permissible limit for the stock is decided by SEBI based on its previous day’s closing.

The lower circuit for different stocks may vary from 2-20% and is fixed by SEBI considering the volume, liquidity, and the category of the stocks. These circuit levels are not permanent and can be altered subject to periodical review. For liquid stocks, the circuit is hiked and for stocks, with dried up liquidity circuit is lowered.

Learn more about the Regulatory Bodies in the Indian stock market in our blog here