Trading Curb Definition

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Trading Curb Definition

What Is a Trading Curb?

A trading curb, sometimes known as a “circuit breaker,” is the temporary suspension of trade in order to rein in excess volatility and restore order.

Markets are termed to be “curbs in” when such a standstill occurs.

Key Takeaways

  • A trade curb is a brief pause to trading that is designed to reduce panic selling on US stock exchanges.
  • Trading halts were originally introduced after the Oct. 19, 1987, stock market disaster to assist avoid negative feedback loops and lessen intraday volatility.
  • The S&P 500 Index is utilized for daily estimates of three trading curb levels that, if achieved, would result in trade halts.

Understanding Trading Curbs

A trading curb, governed by Securities and Exchange Commission (SEC) Rule 80B, is a temporary limitation on trading in a specific securities or market, aimed to decrease excess volatility. Trading restrictions were originally imposed after the stock market disaster on October 19, 1987 (dubbed “Black Monday”), since program trading was deemed to be the principal cause of the catastrophe. In reaction to the so-called Flash Crash of May 6, 2010, the regulation was revised in 2013.

The goal of trading limits is to give the market a chance to recover its breath after being jolted by severe volatility. Temporary trading halts allow market players time to consider how they will react to substantial and unexpected swings in market indexes or individual stocks when the restrictions are restored. All shares, options, and futures traded on US exchanges are subject to the circuit breakers.

Some experts argue that trading limits are disruptive and artificially volatile because they induce orders to pile near the limit level and reduce liquidity. Circuit breakers’ detractors claim that allowing the market to flow freely, without any halts, would result in a more constant equilibrium.

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Curbs In Levels

The S&P 500 Index is the reference index for daily computations of three breakpoints (Levels 1, 2, and 3) that would result in trade halts.

  • Level 1 is a 7% drop from the previous day’s closing of the S&P 500 Index, resulting in a 15-minute trading pause; however, if the 7% drop happens within 35 minutes of market closure, no halt is imposed.
  • Level 2 is a 13% drop that will likewise result in a 15-minute halt; similarly, there will be no trade suspension if the 13% drop happens within 35 minutes of market closing.
  • Level 3 is a 20% decrease, which will result in the stock market shutting for the rest of the day.

A trading halt is implemented on an individual security if there is a 10% change in the value of a security that is a member of the S&P 500 Index, Russell 1000 Index, or QQQ ETF (exchange-traded fund) within a five-minute time frame, a 30% change in the value of a security whose price is equal to or greater than $1 per share, or a 50% change in the value of a security whose price is less than $1 per share.

Individual securities may have trading limits imposed if the price is rising or falling. Circuit breakers related to broad market indexes, on the other hand, are only activated when prices fall.

History of Trading Curbs

On October 19, 1987, known as Black Monday, major financial markets throughout the globe plummeted, causing a domino effect. In the United States, the Dow Jones Industrial Average (DJIA), which acts as a broad barometer of the status of the stock market and economy as a whole, fell by 508 points (22.61%).

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Following the disaster, then-President Ronald Reagan formed a team of specialists. Reagan charged them with developing standards and boundaries to avoid a catastrophic market meltdown from occurring again. The Brady Commission stated that the reason of the collapse was a lack of communication due to a rapid market, which led to misunderstanding among traders and the market’s freefall.

To address this issue, they devised a circuit breaker, sometimes known as a curb, which would cease trading when the market reached a specific level of loss. This momentary halt in trading was intended to allow traders time to converse with one another. The circuit breaker’s initial purpose was not to avoid severe market fluctuations, but to provide time for this communication.

Since then, further trading restrictions have been implemented and come and gone, including a five-day trading restriction program in November 2007.

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