With the market activities improving, the Jamaica stock market has seen the triggering of the circuit breaker regularly over the last few weeks as prices move out of the circuit breaker limit of 15 per cent above the previous day’s close price or effective close price. However, what is a circuit breaker and why do so many exchanges globally institute circuit breaker rules?

The circuit breaker is a measure taken by stock exchanges to rapid fluctuation in the price of a security in any given day which may be caused due to market news that have not been fully disseminated throughout the market or speculations that may not be grounded in facts.

The circuit breaker allows for the cooling off of these types of transactions and therefore manage significant swings in stock prices or indices and avoid price volatility which may result due to large sell-offs based on panic selling. Measures taken by an exchange include activating trading halts or restrictions on trading. Some stock exchanges may require that the trading at the stock exchange be stopped for a certain period beginning from half an hour to even an entire day. The time frame for which trading is stopped can depend upon the amount of movement in the stock prices. The idea is to allow the market to cool down and resume trading at normal levels.

Some stock markets employ a daily circuit breaker, where price limits are set to determine how much a stock price can change in a day. Other stock markets have instituted their own intra-day circuit breaker systems. Most exchanges have established limits to prevent unusual market breakdowns. Some stock exchanges also institute the rule on individual stocks while others apply the circuit breaker to the entire index.

The Jamaica Stock Exchange (JSE) implemented a daily circuit breaker in the 90s to limit volatility in stock prices. After consultation with various stakeholders and market participants, the JSE amended the circuit breaker rule to its current form to permit an intra-day setting which allows the stock to trade at two different reference prices within the day, after a cool down period of an hour.

During the cool down period, news and announcements are released to the market to minimise and clarify any uncertainties, giving investors the opportunity to absorb any new information. When the cool down period has expired, the security trades within a new price band on the same day. However, a limit of 30 per cent is set to prevent any stock from appreciating or depreciating by more than 30 per cent on any day.

The JSE’s trading platform is configured, with the stated parameters, to automatically trigger when the circuit breaker is breached. The circuit breaker is breached when a trade occurs at a price that is more than 15 per cent above the previous day’s close price or effective close price. The circuit breaker will also trigger when a trade occurs at a price more than 15 per cent below the previous day’s close price or effective close price. The close price represents the volume weighted average price of the trades during the day. The effective close price is determined whenever the closing bid is greater than the close price or whenever the closing ask is less than the close price.

When the circuit breaker is triggered for a security, it is automatically halted and restricted from any activity, such as order entry, order editing or order matching. Manual checks are then conducted to determine if the trade that triggered the circuit breaker will be within the new prescribed price band.

The new prescribed price band is determined by calculating +/-15 per cent of the average price of the trigger price and the close price/effective close price. If the trigger price is within the new price band, the security remains halted for an hour and afterwards the trades are only permitted within the new price band. All orders at prices outside of the new price band are placed in a “referred” state.

If the trigger price is outside of the new price band, the trade(s) is cancelled from the system and the security is enabled for trading. Trading is resumed shortly after it is halted to permit activity in the security due to the cancellation of the trade that triggered the circuit. The original reference price and the original price band are also reinstated.

The JSE continues to encourage active trading in the market at prices within limits set to prevent erratic movement in stock prices.