Why Do U.S. Stocks Have Circuit Breaker Systems? An In-Depth Analysis of the Meaning, Trigger Mechanisms, and Historical Impact of Circuit Breakers

What Is the Circuit Breaker Mechanism and Its True Meaning

The concept of circuit breaker comes from the English term “Circuit breaker,” which essentially refers to a market protection device. When the stock market experiences extreme volatility exceeding preset thresholds, trading is automatically paused, providing all participants with a window of calm to think.

In simple terms, a circuit breaker is like stepping on the brakes for investors racing wildly—when market sentiment is overwhelmed by panic and irrational selling spreads, this mechanism forces a halt to trading, allowing everyone to pause, take a deep breath, and reassess the situation. During the Silicon Valley Bank turmoil in 2023, the sharp decline in the US banking sector once again demonstrated the importance of this protective system.

How the Circuit Breaker Truly Works

The US stock market’s circuit breaker system operates during regular trading hours (9:30 AM to 4:00 PM Eastern Time), using the S&P 500 index as a reference. When the index drops by a certain percentage compared to the previous trading day’s closing price, the corresponding level of pause is automatically triggered.

Specific rules for the three circuit breaker levels:

It is noteworthy that within the same trading day, Level 1 and Level 2 circuit breakers can only be triggered once each. If the S&P 500 drops 7% to trigger Level 1, and after trading resumes, it drops another 7%, it will not trigger Level 1 again unless the decline reaches Level 2 or Level 3 thresholds.

Why Establish This Protective System

The core purpose of this mechanism is straightforward: to prevent the market from making self-destructive decisions driven by extreme panic. During significant market swings, rational analysis is often drowned out by emotion, leading many investors to blindly follow the herd and sell off, causing prices to deviate sharply from their intrinsic value.

The value of the circuit breaker system manifests in several aspects:

First, it can prevent “flash crashes.” For example, the historic 1000-point drop in the Dow Jones in five minutes on May 6, 2010, was a consequence of high-frequency trading systems losing control. Such extreme situations are now nearly impossible to recur.

Second, it provides market participants with a buffer, giving everyone a chance to reassess information and adjust expectations. Take the early COVID-19 pandemic in March 2020 as an example: a series of circuit breakers paused the market, but also allowed investors time to digest news and understand the situation, rather than falling into collective hysteria.

Historical Review: Key Moments of US Stock Market Circuit Breakers

Black Monday in 1987 was a turning point. On October 19, the Dow plunged 508 points, a staggering 22.61%, triggering a chain reaction of global stock market crashes. At that time, technical limitations and risk management flaws amplified the decline. Regulators learned their lesson and established the first circuit breaker system.

Since then, over nearly 40 years, the US stock market has experienced only five circuit breaker events:

• 1997 Asian Financial Crisis: Dow Jones Level 1 circuit breaker
• During COVID-19 in 2020: Four Level 1 circuit breakers within a month (March 9, 12, 16, 18)

The month of March 2020 was particularly memorable. Warren Buffett has witnessed five circuit breakers in his lifetime, but many investors experienced four within just over 20 days. Early in the pandemic, infection data was changing daily, global containment measures were highly uncertain, and market expectations for the economy deteriorated sharply. Meanwhile, the Saudi-Russia oil price war caused oil prices to plummet, igniting the stock market storm.

By March 18, the Nasdaq had fallen 26% from its February high, the S&P 500 down 30%, and the Dow Jones down 31%. Although the government quickly announced rescue plans worth billions of dollars, market panic persisted.

The Dual Effects of Circuit Breakers

As a market regulation tool, circuit breakers have both positive effects and potential risks.

Positive effects include alleviating emotions and applying brakes to irrational trading. Injecting a dose of calm during extreme volatility can significantly improve market sentiment.

Negative risks involve potentially exacerbating anxiety. When markets approach the trigger threshold, some investors may rush to sell before the pause, fearing they will miss the window. This “race” mentality can actually intensify downward pressure. To some extent, circuit breakers are a double-edged sword.

Difference Between Market-Wide Circuit Breakers and Individual Stock Halts

It is important to distinguish between the overall market circuit breaker and individual stock trading halts. The former pertains to the S&P 500 index’s overall performance, while the latter (limit up/down) applies to single stocks. If an individual stock experiences excessive volatility (exceeding set price ranges), trading may be restricted for 15 seconds; if not normalized, a 5-minute trading halt may occur.

When Will the Next Circuit Breaker Occur

Circuit breakers are typically triggered by two types of events: unexpected major shocks (such as black swan events like pandemics) or market corrections following overvaluation and expectation reversals.

Given the current macroeconomic situation, although the rate hike cycle has not fully ended and recession fears remain, several factors are improving the overall outlook: First, the government has indicated it is unwilling to experience systemic financial risks (the quick resolution of the March banking crisis is proof); second, the generative AI wave has injected new growth imagination into the market, with tech stocks rebounding noticeably from last year’s downturn; third, companies have completed valuation adjustments and cost optimizations, providing relatively solid support at the bottom.

If a circuit breaker occurs again, the correct response strategies are:

1. Maintain ample cash flow — avoid panic selling all holdings during sharp fluctuations, but keep enough liquidity for emergencies.
2. Carefully select assets — high-quality assets become scarcer in a circuit breaker environment; quality over quantity.
3. Focus on fundamentals — stay away from concept stocks sustained by stories; return to profitability and cash flow.
4. Diversify holdings — spreading income sources and assets can significantly reduce extreme risks.

Summary

The establishment of the circuit breaker mechanism signifies market maturity and serves as a form of protection for investors. Understanding its meaning and operation helps us stay rational during extreme market conditions.

Currently, there are no obvious signals of an imminent circuit breaker. Most investors can adjust their positions according to their risk tolerance. But knowing how to survive crises, when to defend, and when to accumulate—that is true investment wisdom.