Why do US stocks trigger circuit breakers? From Black Monday to the bloodshed lessons of 2020

A Mechanism Written in Blood

On October 19, 1987, the U.S. stock market experienced its darkest day in history. The Dow Jones Industrial Average plunged 508.32 points in a single day, a drop of 22.61%, instantly triggering a chain reaction of plummeting global securities exchanges within hours, and causing a total market collapse. This disaster ultimately led U.S. regulators to establish the circuit breaker mechanism—a “market self-rescue” tool that previously did not exist and was later proven to be indispensable.

It can be said that the circuit breaker was bought with investors’ tears and wealth losses.

What exactly is a circuit breaker?

The English term “Circuit breaker” is very illustrative—like the circuit breaker in your home. When the current overloads or a short circuit occurs, the breaker trips immediately to cut off power, protecting the entire system from burning out.

The principle of the U.S. stock market’s circuit breaker mechanism is exactly the same. When market sentiment overreacts and the S&P 500 drops significantly within a trading day, the circuit breaker acts like a circuit breaker, pressing the “pause button.” Trading is forced to halt, giving investors a cooling-off period to reassess market information and prevent irrational panic selling from further destroying the market.

From another perspective, it’s like watching a horror movie and feeling your heart about to jump out of your chest—then the system automatically presses the pause button for 15 minutes, allowing your heart rate to slow and your mind to cool down before continuing to watch.

How are circuit breakers triggered at different levels?

The U.S. stock market’s circuit breaker mechanism is divided into three levels, with clear and strict trigger conditions:

Level 1 Circuit Breaker: When the S&P 500 drops 7% compared to the previous trading day, trading is paused for 15 minutes (only between 9:30-15:25; no pause after 15:25 unless a Level 3 is triggered).

Level 2 Circuit Breaker: When the S&P 500 drops 13%, the same 15-minute trading halt occurs (within the same time limit).

Level 3 Circuit Breaker: When the S&P 500 drops 20%, trading is halted for the rest of the day until market close.

A key detail is that Level 1 and Level 2 circuit breakers are triggered only once within a single trading day. For example, if the S&P 500 drops 7% and triggers Level 1, even if it drops another 7% later, it will not trigger Level 1 again unless the decline exceeds 13%, which would trigger Level 2.

Why is this mechanism necessary?

The core purpose of the circuit breaker is only one: to prevent market sentiment from spiraling into a systemic disaster.

When the stock market declines sharply, prices are often no longer determined by fundamentals but are manipulated by collective panic. Investors see others selling off and follow suit, creating a stampede effect, leading to severe price distortions and even extreme phenomena.

On May 6, 2010, a trader’s high-frequency trading operations instantly created a large number of short positions, causing extreme market imbalance, with the Dow Jones Industrial Average plunging 1,000 points within five minutes—that’s the infamous “Flash Crash.” In such cases, without circuit breakers to pause trading, the market could continue spiraling down uncontrollably, with unimaginable consequences.

Circuit breakers provide a window for the market to “think calmly.”

Four circuit breakers we witnessed in 2020

The most recent wave of circuit breakers occurred in March 2020. Within just two weeks, the U.S. stock market triggered four Level 1 circuit breakers—an unprecedented frequency since the mechanism was established.

At that time, the background was the global spread of COVID-19. Daily infection data kept breaking records, countries implemented social distancing and bans on gatherings, and global supply chains were thrown into chaos. Coupled with the crude oil price crash in early March (Saudi Arabia and Russia’s production cut negotiations broke down, and Saudi Arabia increased oil output), market panic reached its peak.

• March 9: The S&P 500 fell over 7%, triggering a Level 1 circuit breaker.
• March 12: The index fell another 7%, triggering a second Level 1.
• March 16: The third Level 1 circuit breaker.
• March 18: The fourth Level 1 circuit breaker.

By the close on 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%. Even with the U.S. government announcing rescue packages worth hundreds of billions of dollars and the Federal Reserve expanding liquidity facilities, these only provided temporary relief.

Warren Buffett mentioned in an interview that he had only witnessed five circuit breakers in his lifetime, but in 2020 alone, we experienced four—enough to demonstrate the level of market panic at that time.

The dual nature of circuit breakers

While the circuit breaker mechanism is designed to protect the market, in practice, it also has negative effects.

Positive effects are obvious: interrupt panic chains, give investors time to cool off, and prevent disastrous stampedes caused by irrational behavior.

Negative effects also exist: as the market approaches the trigger levels, some investors may accelerate selling out of fear that once the circuit breaker is triggered, they won’t be able to execute trades immediately. This anticipatory behavior can actually increase volatility and intensify market swings. Additionally, circuit breakers can heighten investor anxiety—if the market is so severe that trading must be paused, does that mean the problem is worse than we think?

This is the duality of any market mechanism: good in intention, but outcomes are often hard to fully control due to complex human nature.

Will the U.S. stock market trigger another circuit breaker?

There is no certain answer, but we can analyze the trigger conditions.

Circuit breakers usually occur in two scenarios: one is sudden, unpredictable black swan events (like pandemics, wars, financial crises), and the other is a reverse shock when the market is at high levels (such as sudden deterioration of economic data or abrupt shifts in monetary policy).

Currently, although the Federal Reserve’s rate hikes have not fully stopped and recession risks remain, there are reasons for cautious optimism:

• Governments have more comprehensive contingency plans (referencing COVID-19 responses in 2020 and the quick handling of the banking crisis in March 2023).
• Market sentiment is relatively manageable; earlier this year, driven by the AI boom, tech stocks continued to rebound.
• The market has developed stronger risk awareness.

Major unexpected events can never be fully predicted, but compared to the initial confusion during the early days of the pandemic in 2020, current market participants and regulators have more mature response systems.

What should you do if you encounter a circuit breaker?

If the U.S. stock market hits the circuit breaker again, the investor’s response principles are simple:

Cash is king, invest cautiously. When a circuit breaker occurs, it usually indicates extreme market chaos, with declining quality of investment opportunities and increased difficulty in risk assessment. The most prudent actions are:

1. Ensure principal safety—have enough cash reserves and avoid all-in positions.
2. Maintain liquidity—during the circuit breaker, liquidity may dry up; keep sufficient cash to handle emergencies.
3. Diversify your portfolio—avoid reliance on a single asset or market; diversify income sources to reduce systemic risk.
4. Continuously build your capacity—during extreme uncertainty, improve your investment skills and risk discernment to prepare for long-term investing.

Market bottoms often appear at the most desperate moments, but only if you survive long enough and are well-prepared.

Summary

The U.S. stock market’s circuit breaker mechanism was born from the blood and tears of the Black Monday in 1987. It presses the pause button at critical moments through a three-tier trigger system (7%/13%/20%), giving market participants a chance to reconsider.

History shows that circuit breakers are not signs of market failure but rather expressions of market self-protection. Although the four circuit breakers in 2020 were frightening, their existence prevented the market from falling into an even deeper abyss.

Whether they will trigger again in the future remains unknown, but what is certain is that maintaining sufficient cash reserves, enhancing risk awareness, and diversifying investments are timeless principles that can protect your wealth in any market environment.