What to do when the US stock market hits a circuit breaker? Understand this "emergency brake" mechanism in one article

In March 2020, investors experienced a terrifying month. In just two weeks, the US stock market hit the “pause button” four times— the S&P 500 index was circuit breaker triggered four times, which is most of the five circuit breakers Buffett has witnessed in his lifetime. Many investors at the time were asking: What exactly is a market circuit breaker? Why does such a mechanism exist? What should I do when a circuit breaker is triggered?

Starting from a Stock Market Crash: Why Was the Circuit Breaker Created?

Rewind to October 19, 1987, known as “Black Monday.” The Dow Jones Industrial Average plummeted 508.32 points in a single day, a 22.61% drop, causing global stock markets to crash. This disaster shocked all regulators, who realized: A “panic button” must be pressed before market sentiment spirals out of control.

Thus, the US stock market circuit breaker mechanism was born.

What is a Market Circuit Breaker: Like a Short Circuit Trip

To understand a market circuit breaker, imagine your home’s electrical circuit. When the current is too high or voltage abnormal, the circuit breaker trips quickly to cut off power—this is a protective mechanism. The principle of the US stock circuit breaker is exactly the same: When market sentiment overheats and stock price fluctuations become too wild, trading systems will automatically “trip,” pausing trading to give investors time to cool down.

It’s like when you’re watching a horror movie and your heart races; someone presses pause, allowing you to breathe deeply for 15 minutes before continuing. In the stock market, this “pause” serves to:

• Break the chain of panic selling
• Give investors a chance to reassess the situation
• Prevent prices from becoming completely distorted

How Does the US Stock Circuit Breaker Work: Three Trigger Levels

The level of the circuit breaker depends on the percentage decline of the S&P 500 index. The entire mechanism is designed very precisely:

Level 1 Circuit Breaker (down 7%)

• Trigger condition: S&P 500 drops 7% compared to the previous trading day’s close
• Handling: Pause all market trading for 15 minutes (effective only during 9:30-15:25 Eastern Time)
• Scope: All stocks stop trading

Level 2 Circuit Breaker (down 13%)

• Trigger condition: The index declines a total of 13% within the same trading day
• Handling: Pause trading again for 15 minutes
• Effect: Further cools the market

Level 3 Circuit Breaker (down 20%)

• Trigger condition: The index drops 20%
• Handling: Market closes for the day, no trading resumes
• Significance: This is the most serious market signal

Within a single trading day, only one Level 1 or Level 2 circuit breaker can be triggered. For example, if the index drops 7% triggering Level 1, trading resumes, but if it drops another 7% afterward, it will not trigger another Level 1, unless the 13% threshold is reached for Level 2.

Why Is the Circuit Breaker Necessary: Prevent Market Out of Control

On May 6, 2010, a famous “flash crash” occurred— a high-frequency trader created大量空单 (large short positions) within just five minutes, causing the Dow to plunge 1,000 points. Such irrational trading frenzy can destroy market confidence.

The core role of the circuit breaker is to prevent such out-of-control situations:

1. Interrupt the spread of panic: Sharp declines often trigger herd behavior—seeing others sell, investors follow suit. Pausing trading can break this chain.

2. Protect investors: Prevent forced transactions at extreme prices, avoiding accounts suffering huge losses unknowingly.

3. Maintain market order: Give trading systems and risk management teams a breather, preventing technical failures from worsening.

Historical Records of Circuit Breakers: Warnings from History

Since the circuit breaker mechanism was officially implemented in 1988, there have been 5 instances of circuit breakers in US stock history:

October 27, 1997—First circuit breaker triggered by the Asian financial crisis

• Market decline: 7.18%
• Level: Level 1
• Effect: Market stabilized after a 15-minute pause

March 9-18, 2020—Four consecutive circuit breakers triggered by COVID-19 pandemic

• Time span: just two weeks
• Number of triggers: four Level 1 circuit breakers in a row
• Background: Surge in global COVID-19 cases, oil prices plummeting, recession fears spreading
• Result: S&P 500 fell over 30% during this period, investor confidence severely shaken

The four circuit breakers in 2020 are particularly notable. At that time, negotiations between Saudi Arabia and Russia over oil production broke down, causing international oil prices to crash; simultaneously, the pandemic spiraled out of control worldwide, with corporate revenues declining and unemployment soaring, leading investors into panic.

The Double-Edged Sword of Circuit Breakers: Market Rescue or Worsening Volatility?

In theory, circuit breakers should stabilize the market, but in reality, another scenario can occur—investors may start selling before the circuit breaker triggers, fearing they won’t be able to escape once trading halts. This can create a self-fulfilling prophecy: selling to avoid the circuit breaker causes the circuit breaker to activate.

It’s like everyone rushing toward the exit; if it’s announced “the door will close,” it can actually increase the risk of a stampede.

Overall, the US stock market circuit breaker mechanism is still more beneficial than harmful. It:

• Effectively prevents another crash like “Black Monday”
• Gives retail and institutional investors time to react
• Ensures the market doesn’t trade completely irrationally

What Should You Do When the US Stock Market Hits a Circuit Breaker

If a circuit breaker is triggered again, investors should respond with:

Stay Rational, Keep Your Defensive Line

• Don’t panic sell just because prices drop sharply
• The circuit breaker is essentially helping you “calm down,” so you should truly stay calm

Prioritize Cash Reserves

• Maintain sufficient cash positions to ensure liquidity
• This allows you to buy the dip during a crash

Focus on Fundamentals

• Distinguish between emotional declines and deteriorating fundamentals
• Good companies may be undervalued temporarily and present buying opportunities

Think Long Term

• Historically, each circuit breaker was not the end
• After panic, there are often opportunities for rebirth

Summary: Circuit Breakers as the Market’s “Safety Valve”

The US stock market circuit breaker mechanism was born out of Black Monday in 1987, with a simple and straightforward purpose—to pause the market when it becomes irrational. The three trigger levels (7%, 13%, 20%) are designed quite reasonably, avoiding overly sensitive frequent halts while preventing total market chaos.

Although the pandemic in 2020 led us to witness four rare circuit breaker events in a short period, it instead underscores the importance of this mechanism. It’s not perfect, but it has prevented potential larger disasters.

Next time you see headlines about “US stock market circuit breaker,” don’t panic—this actually indicates that the market has a self-protection mechanism. Investors should focus on adjusting their mindset during this “pause,” rather than following the panic.