The Hindu Business Line : Of filters and barriers

A circuit filter is an upper/lower limit imposed on the price movement of a stock during a trading day. This is done to limit the erosion or appreciation in value that an investor is likely to experience on a particular day. Once the circuit limit is reached, trading in that stock stands frozen for the day.

The filters called `price bands' on the NSE are applied only to specified stocks. A filter can be a 2 per cent band as in the case of Tanla Solutions or a 5-10 per cent limit. As per the last update available, 3i InfoTech, Inox Leisure and Texmaco are some of the stocks in the 10 per cent band. Assuming that Texmaco is trading at Rs 950, the upper circuit limit will be reached if the price touches Rs 1,045. Likewise, Rs 855 will be the lower limit. CRISIL, Rajashree Sugars and Godrej industries are among those in the 5 per cent bracket.

Scrips such as Bharti Airtel, Unitech and Reliance Industries on which derivative products are available have no circuit filters imposed on them. The over 20 per cent rise in the price of Deccan Aviation on May 17 is a case in point. This upward movement was possible because the NSE had removed the circuit limit on the stock and added it to the Futures and Options (F&O) segment (derivatives segment) on May 14.

A price band of 20 per cent is applicable on all remaining instruments, including debentures, warrants, preference shares. The BSE also has similar filters on its stocks. The list of stocks under the respective circuit filters are reviewed by the both the exchanges from time to time.

Circuit Breakers

If circuit filters are applied to movement in individual stock prices, circuit breakers are applicable to movements in the broad market as captured by the indices. The circuit breaker system applies at three stages of the index movement — at 10 per cent, 15 per cent and 20 per cent. When the Sensex or the Nifty breaches this mark, a nation-wide halt in trading is brought about. The duration of this stoppage varies from half an hour to an entire day depending on the percentage of rise or fall and the part of the day when it happens. For example, in case of a 15 per cent movement of either index, there would be a two-hour halt if the movement takes place before 1 p.m. On May 17, 2004, the circuit breaker was triggered when the market nose-dived following the defeat of the BJP in the general elections. Index-based circuit breakers were activated for the second time on May 22, 2006, halting trading for an hour. The Sensex crashed over 1100 points in intra-day trade amidst fears of a liquidity crisis.

Circuit Filters on IPOs

The recent proposal by the Securities and Exchange Board of India (SEBI) to introduce circuit filters on IPOs is to prevent the artificial jacking up of prices on the day of listing caused by speculative trades in a stock. There are several instances of stocks that have seen wild swings in price on Day One.

For example, ICRA, when it listed earlier this year, opened at a 64 per cent premium to its offer price and ended the day, with a whopping 151 per cent gain. In many cases, buy orders on listing day are not delivery-based and the initial listing gains may be unsustainable. So, circuit filters on the listing day are to shield retail investors from such sharp volatility (though they will not impact the extent of premium or discount at which stocks actually open on listing day).

Circuit filters are not expected to affect the price discovery mechanism, as the market will discover the true value of a stock over a period, if not immediately. The only flip side is that investors looking to cashing-in on listing gains will now have to be content with limited profits as filters might freeze trading, once the stock has zoomed by a certain percentage.

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