When the markets are falling or rising consistently, stocks hitting upper or lower circuit is a common feature. It also means that investors, especially in a falling market, might find themselves unable to exit - at least immediately - from a stock that has hit lower circuit.
For instance, in the last three trading sessions, the Bombay Stock Exchange Sensitive Index, or Sensex, has fallen more than 1,300 points on the back of global cues.
The mayhem saw close to 600 stocks hitting the lower circuit on the BSE. On Monday alone, 216 stocks hit it.
Once the circuit breaker is triggered, it halts further trading in the stock either for a number of hours or for a day. This allows the frenzy to subside and let investors to take a cooler, more rational view of the stock.
A circuit-breaker is applied to the entire index, like the Sensex or the Nifty and to individual stocks as well.
There are three filters for index-based circuit that is 10 per cent, 15 per cent and 20 per cent. In the case of stock-specific circuit filters, the percentage for circuit filter limit is two per cent, five per cent, ten per cent and 20 per cent.
There are no circuits on the 30 stocks included in the Sensex or the 50 included in the Nifty because these stocks are traded in the future and options market as well. In other words, these stocks
can go on a free fall.
When the stock hit their respective circuit filter, one cannot trade in them anymore for the day. If a stock is locked in the upper circuit, it is beneficial for those who are invested in the company whereas if a stock is locked in the lower circuit, it is bad news. This is because once a stock hits the lower circuit, one can do little.
Typically one needs to wait out the day, or if the acquisition price is higher than what the stock is trading at, perhaps days or months together before they can exit.
However, in situation, where one is willing to lose some money, booking losses could be a better idea because once the stock gets into a negative territory with the trading community it could stay there for some time.
Of course, there will be situations that when the stock has fallen significantly for a few days and might see and relief rally when buying coming in due to very good valuations.
One could use that opportunity to exit the stock because the rally is being driven, very often, by traders who want to make a quick buck by getting investors back into the stock.
If the acquisition price is higher than that existing stock price, it makes sense to exit the stock.
Remember an important point, if the stock is hitting the lower circuit because the overall market bias is negative, one could wait for some time for clarity to emerge. But if negative news is driving the stock to lower circuit, it would make sense to exit.