Detailed Explanation of the US Stock Market Circuit Breaker Mechanism: How It Works, Historical Review, and Response Strategies

What Exactly Is a Market Circuit Breaker?

When the market suddenly plunges, have you heard of the concept of a “market circuit breaker”? This seemingly unfamiliar term is actually an important mechanism designed to protect investors.

Market Circuit Breaker (Circuit Breaker) is a symbolic name. Just like a home’s circuit breaker automatically cuts off power when there is an overload, the circuit breaker mechanism in the stock market pauses trading when there is excessive volatility. Imagine you are intensely watching an exciting game, your emotions are fully engaged, and someone presses the pause button for you, giving you a chance to calm down, take a deep breath, reassess the situation, and then continue watching.

In practice, when investor sentiment overreacts and market fluctuations reach a certain level, the market circuit breaker acts like a safety device, intervening to pause trading, giving market participants enough time to absorb new information, clarify their thoughts, and make more cautious investment decisions.

How Does the Circuit Breaker Work? An Overview of Core Rules

During normal trading hours (9:30 AM to 4:00 PM Eastern Time), if the S&P 500 Index drops significantly compared to the previous trading day’s closing price, trading will be halted. The specific pause duration depends on the magnitude of the decline and the timing.

The three trigger levels for the US stock market circuit breaker are:

Level 1 Circuit Breaker (7% decline)

• If the S&P 500 drops 7% from the previous day’s close, it triggers the first circuit breaker
• All stocks in the market are temporarily halted for 15 minutes
• If this occurs after 3:25 PM, trading continues as normal

Level 2 Circuit Breaker (13% decline)

• If the index falls again to 13% within the same trading day, it triggers
• The market is again paused for 15 minutes
• After 3:25 PM, it will not pause again unless the Level 3 circuit breaker is triggered

Level 3 Circuit Breaker (20% decline)

• Triggered when the index drops 20%
• Trading stops for the rest of the day, regardless of when it occurs

It is important to note that Level 1 or Level 2 circuit breakers can only be triggered once per trading day. For example, if the index drops 7% and triggers Level 1, even if trading resumes and the index drops another 7%, it will not trigger Level 1 again—only if the decline reaches the Level 2 threshold will it trigger again.

Why Establish a Circuit Breaker System?

The fundamental purpose of the circuit breaker mechanism is to prevent irrational market-driven movements caused by investor panic. When the stock market drops sharply, panic can spread rapidly, with retail investors selling off in fear as others do, leading to market chaos and price distortions. The circuit breaker acts like a “firewall,” pressing the pause button to allow everyone to calm down.

Specifically, the circuit breaker has several key functions:

First, it prevents excessive market chaos. During large-scale sell-offs, the circuit breaker provides investors with a breather to reassess the situation. For example, during the COVID-19 pandemic in March 2020, the S&P 500 fell by 7%, and after a 15-minute pause, investors had time to think about the global situation rather than blindly selling.

Second, it helps eliminate “flash crashes”. On May 6, 2010, a shocking event occurred: a UK trader used high-frequency trading strategies to create a massive number of short positions in a short period, causing the market to become severely unbalanced, with the Dow Jones Industrial Average plunging over 1,000 points in just 5 minutes. With the circuit breaker in place, such extreme volatility can be promptly halted, allowing the market to recover more quickly and rationally.

What Are the Outcomes of Circuit Breakers?

As a market safeguard, circuit breakers have a dual impact.

On the positive side, they alleviate panic, prevent emotional contagion, protect investors’ assets, and enhance market stability. When the market experiences a sharp decline, the trading halt acts like a “sedative,” calming overly excited market sentiment and reducing investor anxiety.

On the negative side, circuit breakers can sometimes trigger opposite effects. Some investors, fearing being locked out once the circuit breaker is triggered, may accelerate their sell-off, which can exacerbate market volatility and deepen investor insecurity and confidence crises. Therefore, the actual effect of circuit breakers needs to be analyzed comprehensively.

How Do Market-Wide Circuit Breakers Differ from Individual Stock Halts?

US stock market circuit breakers can be divided into two main types:

Market-wide circuit breakers refer to pauses triggered by a certain percentage decline in the S&P 500 Index for the entire day. Once the index hits a specified decline, all stock trading is halted.

Individual stock trading halts (also known as limit up/down or LULD) are designed to prevent sudden, extreme price swings of a single stock. Exchanges set price fluctuation bands for each stock; if a stock’s price exceeds these bands, trading is limited for 15 seconds. If the price does not recover within 15 seconds, trading for that stock is halted for 5 minutes.

A Brief Look at the History of US Stock Market Circuit Breakers

Since the formal establishment of the circuit breaker mechanism in 1988, there have been five instances of circuit breakers. The most notable are the Black Monday in 1987 and the consecutive circuit breaks during the COVID-19 pandemic in 2020.

October 19, 1987: Black Monday and the Birth of the Circuit Breaker System

This day is recorded as “Black Monday.” The Dow Jones Industrial Average plummeted by 508.32 points, a 22.61% drop, triggering a chain reaction of global market crashes within hours, with markets facing total collapse. This catastrophic event prompted regulators to create the first circuit breaker system.

Looking back at the market environment that year: in the first quarter, the Nasdaq soared from 348 to 430 points, a 23.6% increase in three months. By late August, companies started paying dividends, and Nasdaq slightly declined. After reaching new highs in early September, the market began to fall with increased volume, signaling a top. In late September and early October, with more dividend dates approaching, both the Dow and Nasdaq experienced sharp declines. After this crash, regulators decided to establish a circuit breaker system to prevent future single-day drops exceeding 20%.

October 27, 1997: Aftershocks of the Asian Financial Crisis

The Asian financial crisis triggered a sell-off that spread to US markets, with the Dow dropping 7.18%, triggering the first Level 1 circuit breaker, and the market paused for 15 minutes.

March 2020: Four consecutive circuit breaks triggered by the pandemic

The most recent and impactful was in March 2020, when within just one month, the market experienced four circuit breaks. Warren Buffett, a legendary investor, has only witnessed five circuit breaks in his lifetime, but in 2020, we experienced four in a few weeks, highlighting the extreme panic at that time.

At the start of the year, the COVID-19 pandemic erupted globally, with daily new infection records. The virus spread rapidly worldwide. Facing unpredictable pandemic developments and exponential transmission, countries implemented aggressive measures—social distancing, travel restrictions, bans on gatherings, and some regions enforced lockdowns. These measures caused unprecedented disruptions to economic activity and global supply chains.

On March 9, 12, 16, and 18, the S&P 500 triggered Level 1 circuit breakers on four trading days in a row. March 18 was particularly critical: despite the US government announcing multi-trillion-dollar rescue plans and expanding liquidity facilities to support creditworthy companies, these measures had only short-term effects. By the 18th, the Nasdaq had fallen 26% from its February high, the S&P 500 dropped 30%, and the Dow Jones Industrial Average declined 31%.

The core drivers of this wave of circuit breaks stemmed from two factors. First, the collapse of oil negotiations between Saudi Arabia and Russia in early March led Saudi Arabia to increase oil production, causing a crash in international oil prices and igniting the stock market fire. Second, the pandemic spread across industries worldwide, with travel restrictions, production slowdowns, declining corporate revenues, and soaring unemployment fears, prompting investors to seek safe havens, triggering chain reactions of stock sell-offs and short-selling.

Will the US stock market experience another circuit breaker in the future?

Market circuit breakers typically occur when investor panic surges sharply. What situations are most likely to trigger panic? One is unpredictable major emergencies, and the other is external shocks that contradict market expectations when stocks are at relatively high levels.

Black swan events like COVID-19—unprecedented, with unpredictable impacts and unclear responses—often trigger circuit breakers. Alternatively, when the market expects continuous growth and then suddenly the government releases contrary economic data or announces further rate hikes, such expectation reversals can also cause sharp declines.

Major emergencies are inherently unpredictable. Given the current macro environment, concerns about recession still exist, indicating that future risks have not been fully eliminated.

If a circuit breaker is triggered again, investors should not panic excessively. Maintaining a “cash is king” principle is wise—cut expenses, prioritize capital preservation and liquidity. In such market conditions, the probability of encountering high-quality investment opportunities decreases. Over the long term, maintaining the ability to continue investing is more important than anything else, because capital safety always comes first.

Overall Understanding

By thoroughly understanding how circuit breakers operate, their original purpose, real-world impacts, and historical events, we can better see this market safety device.

The US stock market circuit breaker system aims to maintain market stability, helping investors make rational decisions when market sentiment becomes overly inflated. It is divided into three levels: Level 1 (7% decline), Level 2 (13%), and Level 3 (20%), with the first two levels pausing trading for 15 minutes, and the third stopping all trading for the day.

Generally, circuit breakers occur during unpredictable major events or after market peaks when a reversal shock happens. If a circuit breaker is triggered again, investors should focus on maintaining sufficient cash reserves and adopting a cautious investment attitude.