Why do US stocks frequently hit the limit down? An article explaining this "emergency brake" mechanism.

2020 was arguably crazy. In just one month, the S&P 500 hit the circuit breaker four times, and even legendary investor Warren Buffett, who has experienced five such halts, couldn’t help but be amazed. In recent years, the topic of circuit breakers has resurfaced, and investors are starting to get nervous—are these mechanisms the market’s savior or its accelerant?

What is a circuit breaker? Explained in one sentence

The circuit breaker mechanism is called “Circuit Breaker” in English. The concept is simple: when the stock market drops sharply, investor sentiment collapses, and panic selling occurs in large volumes, the exchange will hit the pause button, forcing the market to stop trading.

This isn’t punishing investors; it’s giving everyone a cooling-off period. Just like a circuit breaker automatically trips when an electrical circuit overloads, the circuit breaker intervenes during excessive market volatility, giving everyone time to digest news and reassess the situation, rather than being swept away by panic-driven selling.

How are circuit breakers triggered? Remember these three critical points

The U.S. stock market’s circuit breaker system is divided into three levels, based on the daily percentage decline of the S&P 500:

Level 1 Circuit Breaker: 7% decline

• Triggered between 09:30-15:25, the market pauses for 15 minutes
• If triggered after 15:25, trading continues
• Only triggered once per trading day at this level

Level 2 Circuit Breaker: 13% decline

• Also pauses for 15 minutes between 09:30-15:25
• Continues trading after 15:25 if triggered
• Requires further decline beyond Level 1 to trigger

Level 3 Circuit Breaker: 20% decline

• Triggered at any time, all trading halts for the day
• The ultimate safeguard, indicating market has lost control

In simple terms, the first two levels are like yellow lights, giving a 15-minute cooling-off; the third is a red light, ending all trading for the day.

Why was this mechanism established?

The background for the creation of circuit breakers is quite special. On October 19, 1987, the Dow Jones Industrial Average plummeted 22.61 in a single day, setting the most shocking one-day decline in U.S. stock market history. The market was completely out of control, and global stock markets tumbled in response. Regulators realized they needed a “safety valve” to prevent total market collapse.

Since then, the main purpose of circuit breakers has been to prevent market chaos caused by irrational trading. When stock prices are driven more by emotion than fundamentals, halting trading allows investors time to reassess, reducing the herd mentality that can trigger a wave of panic selling.

At the same time, circuit breakers can prevent “flash crashes.” On May 6, 2010, abnormal high-frequency trading activity caused a massive sell-off, with the Dow dropping 1,000 points in five minutes. With circuit breakers in place, such extreme events can be halted automatically, giving the system a chance to restore rationality.

What did the four circuit breaks of 2020 teach us?

Although circuit breakers have existed since 1988, they became more frequent in 2020. That year, the COVID-19 pandemic suddenly erupted, presenting an entirely unknown threat. The virus spread faster than expected, and countries implemented lockdowns, causing economic activity to nearly halt.

Simultaneously, oil prices crashed. Negotiations between Saudi Arabia and Russia broke down, with Saudi increasing oil production, causing international oil prices to tumble. These shocks compounded, igniting the market fire.

On March 9, March 12, March 16, and March 18, the S&P 500 triggered Level 1 circuit breakers four times. By March 18, the Nasdaq had fallen 26% from its February high, the S&P 500 dropped 30%, and the Dow Jones Industrial Average declined 31%. During that period, unemployment soared, corporate revenues declined, and fears of recession grew, leading to wave after wave of selling.

Can circuit breakers truly stabilize the market?

The answer is “not entirely certain.”

Positive effects: Circuit breakers can indeed act as a stabilizer at certain moments. When everyone is panicking and selling off, halting trading can break the emotional contagion, giving some investors a chance to think calmly rather than follow the herd blindly.

Negative effects: However, sometimes circuit breakers can exacerbate anxiety. Knowing the thresholds exist, some investors may accelerate their selling as they approach the trigger point, fearing they’ll be locked out and unable to cut losses in time. This “front-running” effect can increase market volatility further.

What should investors do if a circuit breaker is triggered again?

First, recognize that circuit breakers usually occur during unpredictable major events—pandemics, wars, financial crises, or black swan events. These are things you cannot accurately predict in advance.

Second, change your mindset. When a circuit breaker happens, the market is full of panic, but also opportunities. If you hold cash, you might be able to buy at lower prices when others are panicking.

Practical tips:

• Maintain sufficient cash reserves to ensure liquidity
• Diversify your investments to avoid concentration risk
• During halts, avoid impulsive buying or selling; use the pause to think calmly
• A long-term perspective is crucial; historically, after every circuit breaker, the market has recovered and reached new highs

Summary

Since its establishment in 1988, the circuit breaker has been triggered five times. It’s not designed to end investments but to give the market a breather. The three-tier system—7%, 13%, and 20% thresholds—corresponds to yellow, yellow, and red lights.

Understanding the essence of circuit breakers can help you stay rational during extreme market conditions. Remember: markets will fluctuate, people will panic, but investors who understand the mechanisms will always find ways to respond.