What Does the US Stock Market Circuit Breaker Mean? An Explanation of the Mechanism, History, and Coping Strategies

The True Meaning of Circuit Breakers: Applying the “Brakes” to the Market

In investors’ daily discussions, the term “circuit breaker” appears frequently, but what exactly does it mean? Simply put, a circuit breaker (Circuit Breaker) is an automatic protective mechanism in the US stock market—when stock price fluctuations exceed a set threshold, trading is paused for a period of time. It’s like a car’s brake system, preventing the market from “crashing” due to excessive panic.

The design concept of this mechanism is straightforward: when investor sentiment is overly amplified and the market experiences violent swings, a pause gives everyone a chance to breathe. Imagine this scenario—when moviegoers in a theater scream and push each other during a horror climax, the theater administrator presses the pause button, allowing everyone to calm down for 15 minutes, take a deep breath, and gather their thoughts before continuing the movie. The principle of the US stock market’s circuit breaker works almost identically.

How the Circuit Breaker Works: Three Levels of Risk Defense

The US stock market’s circuit breaker mechanism sets three trigger levels based on the S&P 500 Index’s comparison with the previous trading day’s closing price:

Level 1 Circuit Breaker: Triggered when the index drops 7%. Between 9:30 AM and 3:25 PM, all stocks are paused for 15 minutes. If triggered after this period, trading resumes (unless a higher-level circuit breaker is triggered).

Level 2 Circuit Breaker: Triggered when the index drops 13%. Similarly, all trading is paused for 15 minutes, within the same time window as Level 1. After 3:25 PM, no pause occurs.

Level 3 Circuit Breaker: Triggered when the index drops 20%. This is the most severe measure—once triggered, all remaining trading for the day stops, and the market closes.

It’s important to note that Level 1 and Level 2 circuit breakers can only be triggered once per trading day. For example, if the S&P 500 drops 7% and then recovers, a second 7% drop will not trigger another Level 1 circuit breaker but will wait until the 13% decline triggers the Level 2 circuit breaker.

Why Are Circuit Breakers Needed: The Market’s “Emotion Regulator”

The birth of circuit breakers was not accidental. On October 19, 1987, the Dow Jones Industrial Average plummeted 22.61%, a day known as “Black Monday,” when the market spiraled out of control. Massive panic selling among investors triggered a chain reaction, causing global stock markets to crash within hours. This disaster prompted regulators to seriously consider: We need a mechanism to prevent the spread of emotion-driven panic.

From a deeper perspective, circuit breakers address three core issues:

First, preventing the cascade effect of irrational emotions. When the market declines, investors see others selling and follow suit, creating a herd effect. Pausing trading breaks this chain, giving people time to reconsider.

Second, preventing market mispricing. Historical “flash crashes” show that in the era of high-frequency and algorithmic trading, severe price distortions can occur within minutes. On May 6, 2010, a trader’s actions caused the Dow Jones to plunge 1,000 points in 5 minutes—circuit breakers can halt trading immediately in such extreme cases.

Third, maintaining market participants’ confidence. Knowing that protective mechanisms exist helps investors stay psychologically stable and avoid making extreme decisions during minor fluctuations.

Historical Review: When Has the US Stock Market Circuit-Breaked?

Since the circuit breaker mechanism was established in 1987, the US stock market has experienced five circuit-breaking events:

• October 27, 1997: The Dow Jones dropped 7.18% due to the Asian financial crisis, triggering a Level 1 circuit breaker.
• March 9 to March 18, 2020: Under pandemic shock, the S&P 500 triggered Level 1 circuit breakers four times in a row.

In particular, in 2020, four circuit breaks within a month were unprecedented. Early in the year, COVID-19 outbreaks kept increasing daily, with global containment measures intensifying and economic activity stalling. Additionally, in early March, disagreements between Saudi Arabia and Russia over oil prices caused a crash in international oil prices, igniting the stock market’s fuse.

During these four weeks, despite the US government launching rescue plans worth hundreds of billions of dollars, investor concerns about the economic outlook persisted. By March 18, the S&P 500 fell another 7%, marking the fourth Level 1 circuit breaker. As of that date, the Nasdaq had dropped 26% from its February high, the S&P 500 declined 30%, and the Dow Jones Industrial Average fell 31%.

Legendary investor Warren Buffett has said he has experienced only five circuit breakers in his lifetime, yet in just one month in 2020, we experienced four—enough to illustrate the extreme panic of that period.

The Double-Edged Sword of Circuit Breakers: Protection or Amplification?

Theoretically, circuit breakers are “safety valves” for the market, intended to ease volatility. But in practice, the situation is more complex.

Positive effects: When the market pauses, investors have time to reassess information, digest negative news, and make rational judgments. Often, a 15-minute pause is enough to calm market sentiment, and when trading resumes, buying and selling forces tend to balance out.

Negative effects: However, some investors accelerate selling as they approach the circuit breaker threshold—worried that once triggered, they might be locked into high-risk positions temporarily. This “front-running” mentality can actually increase market volatility and create a self-fulfilling prophecy. Additionally, the pause itself can heighten anxiety, as increased uncertainty fuels nervousness.

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

Besides the circuit breakers for the entire market, US markets also have individual stock trading halt mechanisms (Limited Up-Limit Down, LULD).

Market-wide circuit breakers target the overall performance of the S&P 500, while individual stock halts are triggered by abnormal price swings of a single stock. When a particular stock experiences extreme volatility within a short period, the exchange imposes a 15-second trading restriction. If the price does not recover to normal levels during this period, the stock is halted for 5 minutes. This is a safeguard against “flash crashes.”

Will There Be Future Circuit Breakers? How Should Investors Respond?

Currently, although the US stock market faces various risks, regulators have learned lessons from the 2020 experience. The Federal Reserve reacts more swiftly to financial risks, and government rescue measures are better prepared. For example, during the Silicon Valley Bank turmoil in March 2023, the Treasury immediately stepped in to stabilize deposits, and the Fed quickly adjusted policies, effectively curbing panic spread.

However, low-probability black swan events always exist. Wars, pandemics, energy crises, and other emergencies can trigger unexpected market reactions. At present, the probability of a circuit breaker being triggered again is not high but never zero.

If the US stock market hits the circuit breaker again:

First, maintain a mindset of holding cash as king. During intense volatility, holding cash gives you more options—you can wait for the best entry points rather than being forced to hold positions.

Second, be cautious rather than panicked. History shows that markets recover after each circuit breaker. After four circuit breaks in 2020, US stocks rebounded sharply over the following months, reaching new highs.

Finally, diversify risks and build capacity. Don’t put all your funds into one sector; diversified allocation reduces single-point risk. Also, use periods of volatility to accumulate knowledge and experience, preparing for the next opportunity.

Summary

The US stock market’s circuit breaker mechanism is a product of market evolution, reflecting decades of practical lessons. Its essence is to break the self-reinforcing cycle of panic through trading pauses, leaving room for rational decision-making. The three trigger levels (7%, 13%, 20%) form a progressive safety net, ensuring the market does not spiral out of control in extreme situations.

Understanding the meaning of circuit breakers hinges on recognizing that: this is not a market malfunction but a sign of market self-healing. Each circuit breaker is an opportunity for investors to learn and improve risk management. Staying alert but not overly panicked, doing thorough research but not overconfidence—this is the wisdom for long-term survival in such markets.