What Does a Circuit Breaker in the US Stock Market Really Mean? Understand the Mechanism, History, and Strategies in One Article

Many investors hear the word “circuit breaker” when reading US stock news, but few truly understand its meaning. During the unforgettable pandemic shock in 2020, the US stock market triggered circuit breakers four times in one month, setting a historical record. So, what exactly does a circuit breaker refer to? Why is this mechanism in place? What should you do when a circuit breaker is triggered? Today, let’s clarify this systematically.

A Simple and Rough Understanding of Circuit Breakers

A circuit breaker (Circuit Breaker) is like an “emergency brake” for the stock market.

Imagine you’re driving on the highway, and suddenly there’s an obstacle ahead. If you don’t brake and just crash into it, the consequences could be disastrous. The same logic applies to the US stock market—when the market drops too sharply and investor sentiment becomes uncontrollable, exchanges will hit the pause button, forcing a halt to trading and giving everyone a chance to cool down and think.

A more professional explanation is: the circuit breaker mechanism is an automatic trading halt system established by US stock exchanges to prevent large market swings. When the S&P 500 index falls by a certain threshold compared to the previous trading day’s closing price, the system automatically triggers a trading pause.

How Many Levels of Circuit Breakers Are There? How Are They Triggered?

The US stock market’s circuit breaker system is divided into three levels, each with different conditions and effects:

Level 1 Circuit Breaker: S&P 500 drops 7%

• Triggered between 9:30 and 15:25, all stocks are paused for 15 minutes
• If triggered after 15:25, no pause occurs (unless a Level 3 is triggered)

Level 2 Circuit Breaker: S&P 500 drops 13%

• Also pauses trading for 15 minutes
• After 15:25, no pause unless a Level 3 is triggered

Level 3 Circuit Breaker: S&P 500 drops 20%

• Stops all remaining trading for the day immediately
• Regardless of when triggered, once this level is reached, trading for the day ends

A key detail: 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 pause, even if it drops another 7% afterward, it won’t trigger another Level 1; only if it continues to fall to 13% will the next level be triggered.

Why Was This Mechanism Established?

On October 19, 1987, the “Black Monday” in US history occurred, with the Dow Jones Industrial Average plunging 22.61% in a single day, causing a global stock market crash within hours. This disaster deeply shocked financial regulators, who realized the need to establish mechanisms to prevent similar market out-of-control situations from happening again.

Thus, the core purpose of the circuit breaker system is twofold: cool down.

When the stock market plunges sharply, investors tend to panic collectively—seeing others sell, they follow suit, causing prices to distort. There have even been “flash crashes”—for example, on May 6, 2010, a high-frequency trader in the UK created thousands of short positions within five minutes, causing the Dow Jones Industrial Average to plummet by 1,000 points instantly. Such irrational market behaviors can lead to irreversible disasters.

The circuit breaker acts like a pause button for an overheated market, forcing investors to stop, take a deep breath, and reassess the situation instead of blindly panicking and selling.

Notable Circuit Breaker Events in History

Since the establishment of the circuit breaker system in 1987, the US stock market has experienced five circuit breakers:

• October 27, 1997: The Asian financial crisis affected US stocks, with the Dow dropping 7.18%, triggering a Level 1 circuit breaker
• March 9, 2020; March 12, 2020; March 16, 2020; March 18, 2020: Four consecutive circuit breakers triggered by the COVID-19 pandemic, all Level 1

The month of 2020 was particularly shocking. Warren Buffett has witnessed five US stock market circuit breakers in his lifetime, yet ordinary investors experienced four of them within just one month.

During that period, the global pandemic erupted, daily infection numbers soared, countries implemented quarantine measures, economic activity stalled, global supply chains broke down, corporate revenues declined, and unemployment soared. Meanwhile, the breakdown of oil negotiations between Saudi Arabia and Russia led Saudi Arabia to increase oil production, causing international oil prices to plummet and further shaking market confidence.

By March 18, the Nasdaq index had fallen 26% from its February high, the S&P 500 down 30%, and the Dow Jones down 31%. Despite the US government announcing billions of dollars in rescue measures and the Federal Reserve expanding liquidity facilities, these measures only provided temporary relief to market sentiment.

Is the Impact of Circuit Breakers Good or Bad for the Market?

This question has no absolute answer because circuit breakers are a double-edged sword.

Positive effects:

• Forcing the market to pause, giving investors a breather and time to think
• Preventing collective panic-driven irrational selling
• Protecting market order and preventing extreme events like flash crashes

Negative effects:

• Investors may rush to sell before the trigger point, fearing they won’t be able to sell once the circuit breaker activates
• Trading halts can increase anxiety and tension among investors
• Sometimes, they can accelerate market volatility rather than calm it

The Difference Between Individual Stock Trading Halts and Market-Wide Circuit Breakers

This is a common confusion. The US stock market actually has two mechanisms:

Market-wide circuit breakers: Triggered by the overall decline of the S&P 500, affecting all stocks

Individual stock trading halts (LULD mechanism): The exchange sets price limits for a single stock; if the stock’s price fluctuates too much within a short period, trading is limited for 15 seconds first, and if it doesn’t recover, trading is halted for 5 minutes

Both are designed to prevent extreme volatility, but their scope and trigger methods are entirely different.

Will There Be Another Circuit Breaker? How Should Investors Respond?

Historical patterns show that circuit breakers usually occur under two circumstances:

1. Black swan events: Completely unexpected major events (e.g., pandemics, financial crises), with no prior market anticipation
2. Negative surprises during a bullish trend: When the economy is doing well but suddenly bad news is announced, or rate hikes exceed expectations

Currently, there are no obvious triggers for a circuit breaker in the US stock market. The Federal Reserve has slowed its rate hikes; AI hype (like ChatGPT) has ignited market enthusiasm; in 2023, the US stock market rebounded significantly; and the government is more cautious. When the banking crisis occurred in March 2023, the US Treasury acted swiftly to stabilize the market.

But no one can predict black swan events accurately, so if a circuit breaker occurs again, how should investors respond?

Core strategy: Cash is king

1. Ensure principal safety—avoid making aggressive decisions in extreme market conditions
2. Maintain liquidity—keep enough cash for emergencies
3. Diversify risk—don’t put all eggs in one basket
4. Invest cautiously—extreme conditions mean fewer good opportunities
5. Continuously build capacity—improve your investment skills and cash flow channels during adverse macro environments

Although circuit breakers can be intimidating, in the long run, their existence actually protects ordinary investors from extreme volatility. Understanding their meaning and mechanism helps you stay rational during the next market shock.

Summary

A circuit breaker is an automatic market protection mechanism, divided into three levels (7%, 13%, 20%). When triggered, trading is paused or halted. The core purpose of this system is to prevent irrational panic-driven market collapse. The most famous incidents are the 1987 Black Monday and the four consecutive circuit breakers in 2020 during the pandemic. While circuit breakers can stabilize the market, they may also increase investor anxiety—they are a double-edged sword. If you encounter a circuit breaker again, remember one principle: cash is king, prioritize capital preservation, and focus on long-term planning.