The question many investors are asking of late is whether they should be doing something in the stock market, i.e., which stocks to buy or sell. Instead of making an emotional decision, we thought to use this note to increase our understanding of the market. Here are some terms to keep you informed about the headlines from the financial markets like – are we in a Bear Market? Is this the end of the Bull Market? Why did S&P pull a Circuit Breaker and what is a circuit breaker anyway?
What is a Bull Market? This is a market in which share prices are rising encouraging asset buying fueled by optimism that positive results will continue for an extended period of time.
What is a Bear Market? Bear markets are the ones in which securities prices fall 20 percent or more from recent highs amid widespread pessimism and negative investor sentiment. A bonus term here is “market correction” which is a milder version of the same phenomenon characterized by a 10% drop.
There are many theories of origins of the terms bear and bull, and here’s a popular one. Bears and bulls were widely considered opposites due to the once-popular blood sport of bull-and-bear fights, and the term bull stands as the opposite of bears. Think of a bear as swiping (down) and bull as raging (up).
What is a circuit breaker? As used in engineering, a circuit breaker is an automatic device for stopping the flow of excess current from an overload in an electric circuit as a safety measure. The “market circuit breaker” serves the same purpose for overload in the stock markets. During a time when markets start declining sharply generally due to panic selling, a market circuit breaker is designed to automatically halt the trading for 15 minutes at a time – this keeps stocks from falling through the floor. This break gives traders time to understand the decline and allows them to think and consume the information so they can make informed decisions.
According to the New York Stock Exchange (https://www.nyse.com/markets/nyse/trading-info), there are 3 circuit breaker thresholds in place on S&P 500. These levels are based on the previous session’s close for this popular index. The rules, that apply only during regular trading hours, are listed below.
Level 1: If the S&P 500 drops by 7%, trading will pause for 15 minutes.
Level 2: If the S&P 500 declines by 13%, trading will again pause for 15 minutes provided the drop occurs on or before 3:25 pm ET (note that regular trading on the U.S. stock markets closes at 4 pm ET). There will be no halt if the drop happens after that.
Level 3: Finally, if the S&P 500 falls by 20%, trading is halted for the remainder of the day.
Even though we saw these circuit breakers triggered for the third time today in six sessions, note that it is a rare occurrence. The prior circuit breaker system was revamped after it failed to prevent the May 2010 flash crash. The current set of breakers were put into effect in February 2013.