What is the Upper Circuit in the Share Market?

Investing in the stock market involves understanding various concepts that influence stock prices. One such important term is the "upper circuit." If you've ever seen a stock price shoot up rapidly and then trading gets stopped, you've likely witnessed an upper circuit in action. But what exactly is an upper circuit, and how does it impact trading? Let's break it down in simple terms.

What is an Upper Circuit?

Upper circuit, meaning the maximum price limit a stock can reach in a single trading session. When a stock hits this limit, trading in that stock is paused because there is too much buying pressure. The upper circuit prevents excessive volatility and protects investors from sudden price spikes.

In simpler terms, if a stock’s price jumps significantly in a short period, exchanges set a limit beyond which trading is restricted. This ensures market stability and prevents excessive buying.

Example of a stock hitting the upper circuit limit

Stock: Cochin Shipyard Ltd
Upper Circuit Limit: 5%
Previous Closing Price: ₹1,577.86
Upper Circuit Price: ₹1,577.86 × 1.05 = ₹1,656.75

On December 2, 2024, Cochin Shipyard hit its upper circuit after bagging a ₹1,208 crore defence contract. The positive sentiment led to a spike in demand, and the stock got locked at the circuit limit with only buyers and no sellers.

How is the Upper Circuit Limit Determined?

The upper circuit limit is determined by stock exchanges based on regulatory guidelines and market conditions. It is set as a percentage of the previous day's closing price and varies based on the stock’s volatility, liquidity, and classification.

Key Factors That Decide the Upper Circuit Percentage:

1. Regulatory Controls: The Securities and Exchange Board of India (SEBI) and stock exchanges define circuit limits to prevent manipulation and excessive speculation.

2. Stock Liquidity: Highly liquid stocks (like blue-chip companies) generally have lower circuit limits (e.g., 5% or 10%), whereas less frequently traded stocks may have higher limits (e.g., 10% or 20%).

3. Market Segment:

   • Stocks in the cash market (regular trading segment) have predefined circuit limits of 2%, 5%, 10%, or 20%.

   • Stocks in the Futures & Options (F&O) segment do not have a fixed circuit limit but follow a dynamic price band of 10% on either side that adjusts based on market trends.

4. Market Conditions: If a stock shows extreme volatility over consecutive sessions, the exchange may adjust circuit limits to stabilise trading activity.

Regulators like SEBI (Securities and Exchange Board of India) ensure that these limits prevent manipulation and excessive speculation.

What Happens When a Stock Hits the Upper Circuit?

When a stock reaches its upper circuit limit, the following things occur:

• Trading pause: Trading is temporarily paused for that stock to avoid any further price increase.

• Drop in trading volume: Buyers may still place orders, but since sellers are unavailable, trading volume drops.

• Increase in pending buy orders: If demand remains high, the stock continues to be in demand but with no sellers, leading to a backlog of pending buy orders.

• Dynamic limits for F&O stocks: For stocks under F&O (Futures & Options) trading, price movement continues but with dynamic limits instead of a hard stop.

Upper Circuit vs Lower Circuit

The terms upper circuit and lower circuit are opposite but serve the same purpose - controlling extreme price movements.

Both upper and lower circuits are implemented to prevent wild market fluctuations and maintain order in stock trading.

Reasons Why a Stock Hits the Upper Circuit

A stock can hit the upper circuit due to multiple reasons, including:

• Positive News - Announcements such as strong earnings, mergers, or policy changes benefiting the company.

• High Demand - Sudden buying interest due to market trends or investor speculation.

• Industry Growth - If a sector sees a major boom, stocks within that sector may rally.

• Government Policies - Favorable changes in regulations or tax benefits can push stock prices up.

• Takeover or Acquisition - A potential acquisition or strategic investment often drives stock prices higher.

• Lower Floating Stock - If very few shares are available for trading, even small demand can cause price spikes.

Advantages and Disadvantages of Upper Circuit

Advantages:

• Prevents Excessive Speculation: Limits prevent stock prices from surging uncontrollably.

• Encourages Stability: Reduces panic buying and maintains orderly trading.

• Investor Protection: Helps avoid sudden price shocks that could mislead investors.

Disadvantages:

• Liquidity Issues: Investors holding the stock may find it difficult to sell.

• Risk of Manipulation: Operators sometimes use upper circuits to create artificial demand.

• Trapped Buyers: If a stock consistently hits the upper circuit, it may suddenly reverse, leaving investors stuck.

How to Trade in Stocks That Hit Upper Circuit?

Trading in stocks that frequently hit the upper circuit requires careful planning. Here’s how:

1. Buy Early in the Session

If a stock is expected to hit the upper circuit, placing a buy order at the opening bell can help secure a position before the price locks.

2. Use Limit Orders

A limit order instead of a market order ensures you buy at a specific price rather than an unpredictable one.

3. Watch Volume & Market Sentiment

Check if the stock is hitting the upper circuit due to genuine demand or speculative hype.

4. Exit at the Right Time

If a stock is rallying due to speculation, exiting early helps avoid being stuck if it reverses.

5. Check the Reason for the Circuit

Understanding why a stock hit the upper circuit can help in making better investment decisions.

Conclusion

Understanding what is upper circuit is in the share market is crucial for both beginners and seasoned investors. While it can indicate strong demand and bullish sentiment, blindly chasing upper circuit stocks can be risky. Always analyse the reasons behind price movements, monitor market trends, and make informed trading decisions to maximize your investments.