Today has been a historical day for the Philippine Stock Exchange (PSE) after it had experience its first ever ‘circuit breaker’ activation - a 15 minute halt in day trading which occurred 11.23AM-11.38AM (GMT +8) local time.

Since this is something new for us Filipinos to hear or watch in the news, I thought it might be interesting that I write something to explain it in layman’s term. Even if only a very little percentage of our 90M population do live trading with a broker.

Stock Market Circuit Breaker

I guess everyone knows what a circuit breaker is. Its an electrical switch that’s automatically-operated, designed to protect an electrical circuit from possible damage that an overload or a short circuit might cause.

Basically, its the same thing with the stock market circuit breaker that got activated today. Only that in stock market terms, a circuit breaker halts trading for a definite period of time, after a market drops a particular level.

In the case of our country’s stock market, the Philippine Stock Exchange, a circuit breaker is set according to this rule:

The temporary trading suspension will be implemented only once in a market session and will not be resorted to if the decrease in the PSEi by at least 10 percent occurs 30 minutes prior to market close at 12 noon.

The PSE registered a 10% day drop at 11:23AM today, 7 minutes short of the 11:30AM deadline, thus causing its ‘circuit breaker‘ to get activated. This in turn temporarily stopped trading activities for 15 minutes or from 11:23AM-11:38AM.

Why the Need for the Tempory Halt?
Have you ever found yourself on a totally panicky moment that caused a series of unfortunate events? For example waking up late in the morning, say 7:30AM when you should be in the office or school by 8:00AM. To make it worse, you have a meeting or a big exam by 8:30. What happen? You get into panic mode and rush, rush, rush! But more often than not, all this panicking and rushing won’t do you any good but in turn would only make things bad. You misplace your stuffs, leave your keys inside the house, trip on the sidewalk, etc. You get the idea.

The same thing happens on a rapidly falling stock market.

For example, by the opening of the market, or 9AM, a trader has 1 million pesos all traded in various shares. By 11AM, let’s assume just for the sake of illustration, that the market and the trader’s capital has fallen 9.5%, or 95K pesos. That’s 95 thousand pesos paper loss in just 2 hours! And the market is not even halfway on its downslide!

So how does Mr. Million trader reacts? He noticed that everyone seems to be cutting their losses and are selling their shares. Figuring out that he’s in deep trouble with his wife once she found out about all the money he lose on the market today, he immediately sell his shares even at a loss just to preserve his remaining capital - and prevent an all out war with his wife.

But remember the law of supply and demand? Too many people selling their stocks and too few wanting to buy them will only cause share prices to drop, and in turn, cause the stock market to decline further.

The problem is, all the declines on the prices of shares in the stock market has nothing to do with the fundamentals of the companies they represent and are all emotion-driven.

Have you heard something like all of PLDT’s unsatisfied DSL subscribers pre-terminating their subscription? No. Yet, their shares fell 14% today. Did Ayala closed all its malls, buildings, insurance company, banks, etc. (or should we say, the entire Makati CBD)? No. Yet, Ayala Corporation’s shares fell almost 12% today. It did not even moved down that big when an explosion happened at Glorietta 2 last year.

If you’re still with me, you should figure out by now that there is really no physical reason on why the value of a company’s stock should drop so sudden. Yet they did today. What caused their decline? Emotion. Mr. Million trader panicked at the thought of going home tonight with the what could be greater than PhP95K loss news to his wife so without giving much thought about it, unreasonably sold his stocks even at a low, luge price.

Just like everyone else in the market.

And so, the PSE circuit breaker was activated after the 10% day drop has been reached, just as it was designed to do so, to give Mr. Million trader, and all his fellow day traders, a 15 minute break, to clear up their minds and figure out, that their heart is starting to rule over their brains.

By the way
Do you know that the use of stock market circuit breaker has been established in Dow Jones, USA’s stock market, after the Black Monday crash in 1987? The circuit breakers have been activated twice, both times in late afternoon trading on Oct. 27, 1997, when the Dow eventually closed off 554 points, or 7.2 percent. Wow, that’s exactly 11 years today!

Furthermore, do you know that the use of circuit breakers on Philippine Stock Exchange has been established, only almost a month ago, or last September 30, 2008? Wow again, the management of PSEi must have one hell of a strong foresight!