Rest in Peace
“Well, China circuit breaker, you had a good run. A short life, to be sure. But you did achieve global fame. […] Let us not dwell on your passing. Let us celebrate your achievements. You came into this world on Monday; you were gone by Thursday. But in just four sessions you shut down the market twice. A 0.5 batting average, we could say. […] For those of us still behind, let us not despair. For there are already reports that you haven’t died, but merely were suspended. We pray for your return.
Until, then, Rest In Peace. (McGee, 2016)”
This was part of the article written by Patrick McGee and published in the Financial Times on Friday 8th January, 2016. Lightened by irony, he summarized the introduction of circuit breakers in China’s stock exchanges.
In order to control the wild gyrations that took place last September in the Chinese stock markets, China’s regulators introduced for the first time on Monday 4th January the circuit breakers. However, on Thursday 7th January, after only 4 days, China decided to suspend this experiment amid fears that circuit breakers had worsen the stock market declines and increased the market volatility.
What is a circuit breaker?
The term “circuit breaker” refers to measures put in place to avert panic in markets by putting temporary halts or a freeze in trading if, for instance, the index in question falls/rises by a pre-determined level (Tang, 2016).
These measures were first introduced in the U.S. stock exchanges after the market crash of October 19, 1987 (Black Monday), when the Dow Jones Industrial Average (DJIA) declined to 508 points, or 22.6%, in one day. To prevent similar events from happening again in the future, the SEC decided to approve these “collars” that temporarily halt trading on an exchange when prices hit pre-defined tripwires. Since February 2013, for the S&P 500 Index, these tripwires have been 7%, 13% and 20%. If the S&P 500 declines in a single day to 7% (Level I) or to 13% or below (Level II) its previous close, all exchanges would be stopped for 15 minutes, unless it occurs at or after 3:25 pm, in which case trading is allowed to continue. Similarly, if the S&P 500 declines to 20% (Level III), trading would be stopped for the remainder of the day[1]. In this way, regulators aim at stopping panic selling, maintaining order in the market and protecting investors’ interests.
What happened in China?
To prevent market crashes like the ones the country experienced last summer, China Securities Regulatory Commission (CSRC) introduced the previously explained mechanism to stop market trades if the CSI 300 Index rises or falls by a certain percentage. In particular, if the CSI 300, an index that replicates the performance of 300 stocks traded in the Shanghai and Shenzhen stock exchanges, moved by 5 per cent in either directions from its previous close, trading across the country's equity indexes stopped for 15 minutes. Differently, if the CSI 300 increased or decreased by 7 per cent, trading stopped for the rest of the day.
So, what happened? As outlined at the beginning, from the 4th to the 7th of January, the Chinese stock market shut down twice due to circuit breakers. On Monday, pulled down by the Shenzhen exchange that declined by 8.2 per cent at the end of the day, the CSI 300 hit the tripwire of 5 per cent at around 13:10 (local time). However, after re-opening, the Index reached 7 per cent after only two minutes. Quicker is what happened on Thursday, when the CSI 300 fell 5 per cent in 13 minutes and kept going to 7 per cent few seconds after trading resumed (Pisani, 2016).
The causes of the decline were various: the December manufacturing PMI survey that was slightly below expectations, the new constraints for small cap stocks, and the devaluation of Yuan etc. However, what is important to highlight is the crucial role circuit breakers played in making the decline quicker. Let’s imagine we were Chinese traders on Monday when markets were approaching the 5 per cent decline. What would we have done? Most probably, we would have sold madly, trying to get our orders in before the fuse was triggered and the markets were halted for fifteen minutes. In this way, however, we would have helped what we were trying to avoid. Then, at 13.24, when the exchanges opened again, what would have been our biggest fear? That the CSI 300 would decline another 2 per cent and the markets shut down for the rest of the day. As a consequence, as soon as the market reopened, we would have sold frenetically causing the market decline to 7 per cent even faster.
As Paul Kedrosky wrote on The New Yorker, “when the circuit breaker happened once it is much more likely to happen again. Investors will remember previous shutdowns, so if they’re leaning toward selling on a given day they’ll try to do so even faster this time, to avoid being caught out (Kedrosky, 2016)”. And this is what happened on Thursday 7th.
(Stay tuned for the second part of the story...)
Giorgia Bulgarelli
“Well, China circuit breaker, you had a good run. A short life, to be sure. But you did achieve global fame. […] Let us not dwell on your passing. Let us celebrate your achievements. You came into this world on Monday; you were gone by Thursday. But in just four sessions you shut down the market twice. A 0.5 batting average, we could say. […] For those of us still behind, let us not despair. For there are already reports that you haven’t died, but merely were suspended. We pray for your return.
Until, then, Rest In Peace. (McGee, 2016)”
This was part of the article written by Patrick McGee and published in the Financial Times on Friday 8th January, 2016. Lightened by irony, he summarized the introduction of circuit breakers in China’s stock exchanges.
In order to control the wild gyrations that took place last September in the Chinese stock markets, China’s regulators introduced for the first time on Monday 4th January the circuit breakers. However, on Thursday 7th January, after only 4 days, China decided to suspend this experiment amid fears that circuit breakers had worsen the stock market declines and increased the market volatility.
What is a circuit breaker?
The term “circuit breaker” refers to measures put in place to avert panic in markets by putting temporary halts or a freeze in trading if, for instance, the index in question falls/rises by a pre-determined level (Tang, 2016).
These measures were first introduced in the U.S. stock exchanges after the market crash of October 19, 1987 (Black Monday), when the Dow Jones Industrial Average (DJIA) declined to 508 points, or 22.6%, in one day. To prevent similar events from happening again in the future, the SEC decided to approve these “collars” that temporarily halt trading on an exchange when prices hit pre-defined tripwires. Since February 2013, for the S&P 500 Index, these tripwires have been 7%, 13% and 20%. If the S&P 500 declines in a single day to 7% (Level I) or to 13% or below (Level II) its previous close, all exchanges would be stopped for 15 minutes, unless it occurs at or after 3:25 pm, in which case trading is allowed to continue. Similarly, if the S&P 500 declines to 20% (Level III), trading would be stopped for the remainder of the day[1]. In this way, regulators aim at stopping panic selling, maintaining order in the market and protecting investors’ interests.
What happened in China?
To prevent market crashes like the ones the country experienced last summer, China Securities Regulatory Commission (CSRC) introduced the previously explained mechanism to stop market trades if the CSI 300 Index rises or falls by a certain percentage. In particular, if the CSI 300, an index that replicates the performance of 300 stocks traded in the Shanghai and Shenzhen stock exchanges, moved by 5 per cent in either directions from its previous close, trading across the country's equity indexes stopped for 15 minutes. Differently, if the CSI 300 increased or decreased by 7 per cent, trading stopped for the rest of the day.
So, what happened? As outlined at the beginning, from the 4th to the 7th of January, the Chinese stock market shut down twice due to circuit breakers. On Monday, pulled down by the Shenzhen exchange that declined by 8.2 per cent at the end of the day, the CSI 300 hit the tripwire of 5 per cent at around 13:10 (local time). However, after re-opening, the Index reached 7 per cent after only two minutes. Quicker is what happened on Thursday, when the CSI 300 fell 5 per cent in 13 minutes and kept going to 7 per cent few seconds after trading resumed (Pisani, 2016).
The causes of the decline were various: the December manufacturing PMI survey that was slightly below expectations, the new constraints for small cap stocks, and the devaluation of Yuan etc. However, what is important to highlight is the crucial role circuit breakers played in making the decline quicker. Let’s imagine we were Chinese traders on Monday when markets were approaching the 5 per cent decline. What would we have done? Most probably, we would have sold madly, trying to get our orders in before the fuse was triggered and the markets were halted for fifteen minutes. In this way, however, we would have helped what we were trying to avoid. Then, at 13.24, when the exchanges opened again, what would have been our biggest fear? That the CSI 300 would decline another 2 per cent and the markets shut down for the rest of the day. As a consequence, as soon as the market reopened, we would have sold frenetically causing the market decline to 7 per cent even faster.
As Paul Kedrosky wrote on The New Yorker, “when the circuit breaker happened once it is much more likely to happen again. Investors will remember previous shutdowns, so if they’re leaning toward selling on a given day they’ll try to do so even faster this time, to avoid being caught out (Kedrosky, 2016)”. And this is what happened on Thursday 7th.
(Stay tuned for the second part of the story...)
Giorgia Bulgarelli