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Circuit-breakers refer to a collection of rules set forth by the stock markets themselves to prevent extreme volatility in stock prices. Sometimes market conditions cause a snowball effect, which could result in severe drops or hikes in the stock prices. This is normally accompanied by high trade volumes, usually caused by electronic trading which can move large numbers of shares in a relatively short time. Without a means to stop electronic (or computerized) trading, share prices could quickly make enormous moves to the plus or minus sides, leaving the market in disarray. Circuit-breakers are designed to curb trading activities when such conditions occur. These curbs, also known as collars, in effect shut down the computers for a period of time, allowing only manual trading. The end result hopefully is to bring back stability by injecting some sanity into the market and giving traders time to think about their trading actions. This effect is very evident when a volatile stock market stabilizes itself the day after. Overnight, traders get a chance to calm down and digest what has happened during the day before going back to trading the next day.

With tensions high, panic and euphoria can quickly set in and if left unchecked, can feed themselves into a frenzy. An example of these trading curbs are the NYSE programmed (electronic) trading collar which is triggered when the market moves 180 points in either direction. There are also multiple numbers of circuit-breakers that are triggered if the market drops by 10%, 20%, or 30%. A 30% drop in the market causes an automatic shutdown of the NYSE for the remainder of the trading day.

You may be wondering, with so much money floating around in the stock market, who can keep track of and settle traders' activities in a timely and efficient manner? That job falls on certain institutions known as clearing houses.We covered the concept of clearing houses in the Futures chapter. Their job as related to stocks is pretty much the …