In-Depth Analysis of the US Stock Market Circuit Breaker Mechanism: From Black Monday to 2020 Circuit Breaks

When the stock market crashes suddenly—this is the function of the US stock market’s circuit breaker mechanism. As one of the most important financial markets in the world, the trading rules of the US stock market have reference significance for global investors. This article will analyze the underlying principles of this mechanism, its origins, and its real impact from the perspective of actual operation.

Core Principles of the Circuit Breaker Mechanism

Circuit Breaker borrows from physics—the principle that when a circuit fails and overloads, the circuit breaker will immediately cut off power to protect the system. The US stock market has adopted this concept to design its own risk protection mechanism.

In actual trading, the circuit breaker mechanism is triggered when the S&P 500 index drops more than a set percentage within a single day, causing the exchange to temporarily halt market trading. This pause is not indefinite but provides investors with a cooling-off period—to stop and reassess the situation rather than panic and sell blindly.

Imagine a movie theater suddenly losing power; the audience might initially panic, but this brief interruption can give people a chance to realize they might just be frightened by the scene on the screen. The circuit breaker mechanism exists precisely for this purpose—it forces the market to calm down.

The Three-Level Trigger System of the US Stock Market Circuit Breaker

According to the rules, when the S&P 500 index declines compared to the previous trading day’s closing price, the circuit breaker is activated in a stepwise manner based on the following standards:

Level 1 Circuit Breaker: 7% decline

• Trigger condition: S&P 500 drops 7% in a single day
• Market response: All trading is paused for 15 minutes
• Time limit: Effective only between 9:30 AM and 3:25 PM; if triggered after 3:25 PM, trading continues

Level 2 Circuit Breaker: 13% decline

• Trigger condition: S&P 500 declines 13% in a single day
• Market response: All trading paused again for 15 minutes
• Time limit: Same as above, effective before 3:25 PM

Level 3 Circuit Breaker: 20% decline

• Trigger condition: S&P 500 declines 20% in a single day
• Market response: All trading stops immediately for the day, and the trading session ends
• Time limit: Regardless of when triggered, trading does not resume on that day

It is noteworthy 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 triggers a Level 1 circuit breaker, trading resumes. Even if it drops another 7%, it will not trigger another Level 1; only if the decline reaches 13% will the Level 2 be activated.

Why Is a “Safety Valve” Needed?

Historically, the US stock market experienced Black Monday in 1987. On that day (October 19), the Dow Jones Industrial Average plunged 508.32 points, a 22.61% drop, triggering a chain reaction of global stock market crashes. This epic collapse shook the entire financial system and made regulators realize the need for a protective mechanism.

The circuit breaker was born out of this painful lesson. Its purposes include:

Preventing a vicious cycle driven by emotional panic: When the market drops sharply, investors tend to panic collectively. This panic triggers a chain reaction—seeing others sell off, they panic even more, leading to further selling, creating a “stampede.” The circuit breaker breaks this cycle.

Avoiding “flash crashes”: On May 6, 2010, an extreme event occurred—high-frequency trading algorithms caused the Dow Jones to plunge 1,000 points within 5 minutes, then rebound quickly. Such irrational volatility can cause unnecessary losses for investors. The circuit breaker can effectively prevent such extreme market movements.

Maintaining market order: When the market is in panic, the trading system itself can become overloaded. Pausing trading provides space for technical systems and participants to adjust.

The Dual Effects of the Circuit Breaker Mechanism

As a market safeguard, the actual impact of the circuit breaker mechanism is complex.

Positive effects: The circuit breaker has indeed played a stabilizing role during multiple crises. When investors see the market pause, they have time to reassess the situation. Numerous studies show that halting trading can effectively reduce overreactions afterward. For example, after four circuit breaks in 2020, each pause was followed by a partial rebound, preventing a more disastrous outcome.

Potential negative effects: However, the circuit breaker can also intensify anxiety. Knowing that a circuit breaker might trigger, investors may rush to sell before the pause, fearing they cannot exit during the halt. This “front-running” behavior can increase market volatility and even accelerate declines. Some investors may feel more nervous because of the existence of the circuit breaker.

Therefore, the actual effectiveness of the circuit breaker depends on market sentiment and specific circumstances. It is not a perfect solution but a balance between controllable and uncontrollable factors.

The Difference Between Market-Wide and Individual Stock Circuit Breakers

The US stock circuit breaker system includes two levels:

Market-wide circuit breaker: The mechanism for the overall decline of the S&P 500, as described earlier with the three levels. It activates during systemic crises.

Individual stock circuit breaker (trading halt): Limits the price movement of a single stock. If a stock’s price changes more than a set percentage within 5 seconds, it enters a 15-second trading restriction mode. If not normalized within 15 seconds, the stock is halted for 5 minutes. This aims to prevent “flash crashes” of individual stocks.

Both mechanisms complement each other, forming a multi-layered market protection system.

Retrospective of the Five Major Circuit Break Events

Since the official implementation of the circuit breaker in 1988, there have been five instances:

October 27, 1997: The Asian financial crisis affected the US market. The Dow fell 7.18% in one day, triggering a Level 1 circuit breaker, with a 15-minute trading halt. This relatively mild response indicated the mechanism worked well.

March 2020’s four consecutive circuit breaks: The most dramatic. Within ten days, the US experienced four Level 1 circuit breaks.

• March 9: S&P 500 down over 7%
• March 12: S&P 500 down over 7%
• March 16: S&P 500 down over 7%
• March 18: S&P 500 down over 7%

All caused by panic related to COVID-19. From initial uncertainty, lockdown measures, to economic stagnation, the market experienced the largest adjustment in three months.

At that time, oil prices plummeted (Saudi-Russia oil agreement collapse), supply chains were disrupted, corporate earnings forecasts were sharply revised downward, and unemployment soared. By March 18, the S&P 500 had fallen 30%, the Dow 31%, and Nasdaq 26%. Many investors experienced unprecedented market volatility.

How Should Investors Respond to Circuit Breakers?

Will the US stock market trigger circuit breakers again in the future? The answer is likely “yes.” History shows that whenever unpredictable major events occur or economic conditions change unexpectedly, markets can trigger circuit breakers.

During a circuit breaker, investors should consider:

Adopting a “cash is king” mindset. When the market is full of uncertainty, holding cash is smarter than rushing to sell. Ensuring sufficient liquidity to handle emergencies and protect principal is the top priority.

Maintain rational decision-making. The circuit breaker itself provides a cooling-off period. Don’t waste these 15 minutes. Use the pause to reassess your portfolio and risk tolerance, rather than blindly selling off.

Have confidence in long-term investments. Short-term circuit breakers do not change long-term trends. Historically, after each circuit breaker, the US stock market eventually rebounded and reached new highs. Excessive panic often means missing subsequent rebound opportunities.

Summary

The circuit breaker mechanism is a safety measure designed by the US stock market to prevent systemic risks. Through a three-tier trigger system (7%, 13%, 20%), it acts as a hand on the edge of market chaos. Since its establishment after Black Monday in 1987, it has been tested through multiple market crises.

Although not perfect—sometimes it can amplify short-term volatility—the mechanism overall provides necessary stability. Whether for novice investors or experienced traders, understanding the circuit breaker is an important step in grasping how the US stock market operates.

When the next circuit breaker occurs, instead of panicking, it’s wiser to seize that calm period to reflect—this is the mark of truly smart investors.