Detailed explanation of stock market circuit breakers: from Black Monday in 1987 to four halts in 2020

When it comes to circuit breakers in the US stock market, many investors’ first reaction is panic. But do you really understand how this mechanism works? A circuit breaker, simply put, is the market’s “safety switch”—when stock volatility becomes too extreme, the system automatically pauses trading, giving everyone a chance to take a breath and think calmly.

A Simple Analogy: Understanding the Essence of US Stock Market Circuit Breakers

Imagine you’re watching a suspenseful movie, the plot thickens and becomes more intense, your heartbeat accelerates, almost jumping out of your chest. Suddenly, the movie pauses, giving you 15 minutes to rest, allowing your heart rate to return to normal and your mind to clear. The US stock market circuit breaker works in a similar way.

From a technical perspective, the term “circuit breaker” originates from the circuit breaker in electrical systems. When a circuit shorts or overloads, the breaker quickly cuts off power to prevent a fire. Similarly, in the stock market—when price fluctuations trigger certain thresholds—the market automatically pauses to prevent investors from making irrational decisions driven by extreme panic.

Three Levels of Trading Halt Rules

The US stock market’s circuit breaker is divided into three levels, triggered by the S&P 500’s daily percentage decline:

Level 1 Circuit Breaker: 7% Drop

• Triggered between 9:30-15:25
• Measure: Market-wide trading halts for 15 minutes
• Special case: If triggered after 15:25, trading does not halt (unless it reaches Level 3)

Level 2 Circuit Breaker: 13% Drop

• Triggered between 9:30-15:25
• Measure: Market-wide trading halts for 15 minutes
• Special case: If triggered after 15:25, trading does not halt (unless it reaches Level 3)

Level 3 Circuit Breaker: 20% Drop

• Triggered at any time during the trading day
• Measure: Trading is halted for the remainder of the day until close
• Consequence: The most severe market pause

An important detail: within the same trading day, Level 1 and Level 2 circuit breakers can only be triggered once. For example, if the S&P 500 drops 7% and triggers Level 1, even if it rebounds and then drops another 7%, Level 1 will not trigger again. Only when the decline reaches 13% will a new pause occur.

Why Was This Mechanism Established? Starting from 1987

On October 19, 1987, the US stock market experienced its darkest day ever. Known as “Black Monday,” the Dow Jones Industrial Average plunged 508.32 points, a 22.61% drop. This catastrophic crash triggered a chain reaction across global exchanges, causing many to halt trading within hours.

Looking back, from the start of that year, the Nasdaq soared from 348 to 430 points in just three months, a 23.6% increase. This overexuberance led to severe overvaluation. By September and October, as dividend payout days arrived, investors began taking profits, and the market peaked before sharply declining. This crisis nearly destroyed the entire financial system, prompting regulators to introduce the circuit breaker mechanism—to prevent history from repeating.

Since then, over 36 years, the US stock market has only experienced five circuit breaks:

• October 27, 1997: Impact of the Asian Financial Crisis, Dow fell 7.18%, triggering Level 1
• March 9-18, 2020: COVID-19 pandemic impact, four instances of Level 1 triggers

The Four Circuit Breaks During the 2020 Pandemic: Recent Panic Memories

The most recent and impactful circuit breaker events occurred in 2020. Within just two weeks, the US stock market experienced four trading halts, three of which were Level 1.

When the COVID-19 virus began spreading globally early that year, few understood the severity of the crisis. Daily new case numbers surged, and the virus spread rapidly across continents. To contain it, countries implemented unprecedented measures: social distancing, bans on gatherings, economic shutdowns. Global supply chains were disrupted, and corporate earnings forecasts were sharply cut.

Adding fuel to the fire was the collapse of the oil market. In early March, negotiations between Saudi Arabia and Russia broke down, leading Saudi Arabia to significantly increase oil production, causing international oil prices to plummet. This was the spark that ignited the stock market.

On March 9, 12, 16, and 18, the S&P 500 dropped over 7% four times, triggering trading pauses each time. By March 18, investor panic peaked—Dow Jones plunged 2,999 points in a single day, a 12.9% decline. By that day, the Nasdaq was down 26% from its February high, the S&P 500 down 30%, and the Dow down 31%.

Despite the US government announcing hundreds of billions of dollars in rescue plans and the Federal Reserve cutting interest rates, market sentiment did not stabilize immediately. This pandemic-induced circuit breaker crisis only truly eased later on.

Do Circuit Breakers Really Stabilize the Market? The Double-Edged Sword

In theory, the purpose of circuit breakers is good:

Positive effects:

• Provide investors time to cool off and think, avoiding collective irrational selling
• Prevent “flash crashes” (like the 2010 May 6 event where the market plunged 1,000 points in 5 minutes)
• Give the market a breather to reassess risks

Potential negative effects:

• As the trigger point approaches, investors may become more anxious, accelerating sell-offs to avoid being locked in
• The pause itself might reinforce panic—since trading stops, it signals that the situation is dire
• In the short term, it could increase volatility rather than reduce it

In reality, circuit breakers are like any policy intervention—they have pros and cons. The key is how investors understand and respond to them.

The Difference Between Single-Stock and Market-Wide Circuit Breakers

It’s important to distinguish that the US stock market has two types of circuit breaker systems:

Market-wide circuit breaker: Triggered when the S&P 500 declines sharply, halting all trading across the market.

Single-stock circuit breaker (also called limit up/down): For individual stocks experiencing extreme volatility. If a stock’s price moves beyond a set percentage within 15 seconds, trading for that stock is limited for 15 seconds; if it remains volatile, trading is halted for 5 minutes. This prevents abnormal moves caused by technical glitches or market manipulation.

Will There Be Another Circuit Breaker in the Future?

Predicting the next circuit breaker is quite difficult because they are usually triggered by “black swan” events—unexpected, impactful shocks. These events share common features:

• Very low predictability (no one can forecast them fully)
• Wide-ranging impact (affecting the entire economy)
• Uncertain policy responses (unclear how governments will react)

From the current macroeconomic perspective:

The Federal Reserve has not stopped raising interest rates but has slowed the pace. While recession fears remain, the early-year rebound driven by tech stocks indicates market sentiment is improving. The explosive growth of ChatGPT and AI tools has rekindled market enthusiasm, and investors are seeing new opportunities after a year of stagnation.

On the policy front, the US government has explicitly stated it will not let the market fall into crisis again. During the banking turmoil in March 2023, the government acted swiftly to backstop, promising to protect all deposits. This underscores the importance placed on financial stability.

Currently, the conditions for triggering a circuit breaker are not yet ripe. But that doesn’t mean it will never happen—if a sufficiently significant black swan event occurs, the market could still be triggered.

What Should You Do If a Circuit Breaker Actually Happens?

When a circuit breaker is triggered, staying calm is the top priority. This is precisely the purpose of the mechanism—to give you 15 minutes (or longer) to reconsider.

Key recommendations:

1. Hold Cash: Ensure you have sufficient cash on hand instead of being fully invested. Cash acts as a safety cushion and an opportunity fund.

2. Assess, Don’t Panic: Use the pause to review your portfolio. Is this a cyclical correction or a systemic crisis? Different situations require different responses.

3. Diversify Risks: Since circuit breakers often occur across the entire market, diversification within stocks alone isn’t enough. Asset allocation across stocks, bonds, and cash should be more balanced.

4. Think Long-Term: Historically, markets recover from any crash. If your investment horizon is over 5 years, a circuit breaker can even present a buying opportunity.

5. Be Cautious with New Positions: In times of high uncertainty, rushing to build new positions is unwise. Wait until the situation clarifies and the market stabilizes before acting.

Final Thoughts

The US stock market’s circuit breaker mechanism is a response to the 1987 Black Monday and is a systemic safeguard. It reminds us that markets can indeed experience extreme situations, but it also provides us with time and tools to respond.

The core idea behind circuit breakers is: Markets have self-correcting mechanisms, and as investors, you need to understand these, respect market laws, protect your principal, and prepare for long-term investing.

Whether or not a circuit breaker is triggered, these principles remain timeless.