Volatility is a measurement of the returns for a specific security or a market index and how those returns are dispersed, which can help inform a determination of risk. Generally speaking, the higher a security or market index’s volatility, the higher the risk level of that security or index. In the context of securities markets, volatility is often discussed when there are big swings up or down over a given period.
Volatility is a feature of the markets, and investors should consider elements of volatility when evaluating making investments in individual stocks or ETFs that track indexes. Remember, a higher volatility means a higher likelihood that the price of a security or index can vary widely in a short period of time. Securities or indexes whose value does not fluctuate very much can be thought of as having lower volatility.
What is a circuit breaker?
A circuit breaker is a market mechanism put into place by the U.S. Securities & Exchange Commission that halts trading in individual securities or in certain market indices when certain thresholds are met. These mechanisms – which halt trading in securities that meet those thresholds - were first established after the 1987 market crash known as Black Monday.
On that day, October 19, 1987, the Dow Jones Industrial Average dropped more than 22% in one day. From 1987 through early 2013, circuit breakers were only place for individual securities experiencing drastic swings in price in either direction. Since February 2013, however, the trading halts brought about by circuit breakers can also apply to certain indices experiencing large declines, including the S&P 500 Index. Importantly, the market index circuit breakers only apply to downward swings in price while both up- and downward swings can trigger circuit breakers in individual securities.
How do circuit breakers work?
Circuit breakers are intended to cool the trading activity in a security or index by halting trading. There are three types of circuit breakers.
Level 1 circuit breakers halt trading when the price of a stock or value of an index swings by 7% from its previous market close and are in effect for 15 minutes.
Level 2 circuit breakers trigger when that swing in price or value is 13% and are also put in place for 15 minutes.
Level 3 circuit breakers are put into place – halting trading in a security or market index – when the price or value swing reaches 20%. Level 3 circuit breakers remain in place for the remainder of the day.
A market decline that triggers a Level 1 or Level 2 circuit breaker before 3:25 p.m. will halt market-wide trading for 15 minutes, while a similar market decline “at or after” 3:25 p.m. will not halt market-wide trading. A market decline that triggers a Level 3 circuit breaker, at any time during the trading day, will halt market-wide trading for the remainder of the trading day.
An important note with circuit breakers is that ETFs are treated as individual stocks – not as market indices – even though they track market indices. That means that swings in either direction can trigger a circuit breaker in an ETF, as opposed to only downward swings.
How can circuit breakers affect me?
If a circuit breaker is triggered in a stock or ETF you own or want to own, we may not be able to fulfill your order in the window you want. Depending on whether the trigger is a Level 1, 2 or 3, we may not be able to execute your trade on the day you requested it. Regardless of what happens, we will communicate with you and inform you on the conditions that kept us from trading.
For more information on circuit breakers and trade halts visit the SEC’s Investor.gov website.