What is a circuit breaker and why was there a stock market trading halt Monday?
Through all the chaos, days like Monday are very interesting. While all this short term volatility will have minimal impact on investment values over the long term, we wanted to explain the stop-loss rules in place to curb short-term market selloffs.
What happened on Monday?
Just 4 minutes after opening the S&P 500 was down 7% from it’s closing value on Friday, March 6th. The drop was caused by a significant decline in oil markets over the weekend combined with continued fears surrounding COVID-19. While 7% is a relatively small drop (especially when compared to more recent events such as Q4 2018 when markets were down 19%) what made this drop significant was how fast it occurred.
Why was trading halted?
This goes back to an event we now refer to as “Black Monday”. In 1987 the DOW dropped an unprecedented 22% in a single day. That record still stands as the index’s largest single day decline. Much of what goes on in the stock market happens based on traders’ perceptions at any given moment. If too many traders sell too rapidly, the sense that the markets are trending downward will spread across the trading floor, triggering more and more frenzied selling. After 1987, policies were implemented to give traders a pause from the frenzy and remove the pressure to act hastily. By giving traders time to properly assess the situation clearer heads are able to prevail.
How do Circuit Breakers work?
Circuit breakers, also known as Trading Curbs or Trade Halts have threshold levels at which point they kick in to stabilize market declines. The current system as implemented by the NYSE has 3 levels:
- If the S&P 500 declines 7%, trading will pause for 15 minutes. This is what happened on Monday.
- If the S&P 500 declines 13%, trading will again pause for another 15 minutes, as long as the decline occurs on or before 3:25 p.m. If the decline happens after that, trading continues normally until the markets close at 4 p.m.
- If the S&P 500 falls 20%, the markets close for the rest of the day.
By shutting down for 15 minutes investors have time to absorb information, better understand what is happening in the markets, and make decisions accordingly. Since implementation the NYSE has only closed once. This occurred in 1997 during the Asian Financial Crisis.
Do Circuit Breakers work?
Trading on the NYSE re-started at 9:49am on Monday and within minutes the S&P 500 stabilized. While it remained down 6% through mid-day and closed down just over 7%, at no point was there fear of triggering another circuit breaker. To us, this implies that the circuit breaker did exactly what it was intended to do – it slowed down the explosive panic and let the markets breathe.
While market turbulence can be unnerving, the same rules apply to long term investing: Don’t make decisions based on fear, invest for the long run and take advantage of cheaper prices. Just as 1987 now appears as a tiny blip, in March 2053, this Monday will too.
As always, if you have questions or concerns, we are happy to talk.
