Daily Trading Limit

What Is a Daily Trading Limit?

A daily trading limit is the maximum price range limit that an exchange-traded security is allowed to fluctuate in one trading session. Limit up is the maximum amount a price is permitted to increase during one trading day. Limit down is the maximum permitted price decline occurring over one trading day. Trading limits are examples of circuit breakers (also known as trading curbs) — interventions employed by exchanges to help maintain orderly trading conditions during turbulent markets.

Daily trading limits are often used in the derivatives market, especially for options or futures contracts, to limit excessive volatility. Exchanges impose these limits to protect investors from extreme price movements and to discourage potential manipulation within the markets.

Understanding Daily Trading Limits

Daily trading limits are price ranges established to curtail excessive volatility that can be detrimental to the orderly functioning of markets, especially in highly volatile derivatives markets. Their purpose is to lower extreme market volatility or manipulation in relatively illiquid markets, especially since derivative markets are characterized by their high levels of leverage.

Here’s a hypothetical example: Suppose the daily trading limit for a particular commodity is 50 cents per bushel and the previous day’s settlement was $5.00. In this case, traders cannot sell for less than $4.50 or buy for more than $5.50 per bushel during the current session.

If either of the daily trading limits were to be reached, this commodity would be deemed to be a locked market. It would also be described as having gone limit up or limit down based on whether the upside or downside limit was reached.

How Daily Trading Limits Impact Traders

Daily trading limits can significantly affect trading given that prices can potentially move higher or lower much more quickly once the respective extreme has been reached.

For example, U.S. wheat futures locked up 30-cent daily trading limits in early 2008 for several consecutive sessions amid heavy buying from both speculators and grain users. The underlying cause of the volatility was driven by an uncommon amount of crop losses that reduced supply. In response, the Commodity Futures Trading Commission (CFTC) raised the daily trading limits and exchanges increased margin requirements to suppress speculator demand.

A central bank sometimes imposes daily trading limits on its currency to try and control instability in the currency markets.

Currency markets are a popular example of daily trading limits imposed by central banks to control any instability. In the past, for example, the People's Bank of China has imposed a daily trading limit on the renminbi, allowing it to move within a band as narrow as 0.3% and as a wide as 2%. Central banks defend these trading limits by changing the composition of their foreign exchange reserves.

Daily trading limits can also influence asset valuations. Fundamental factors may have an effect on the true value of a futures contract or currency, for example, but an inability to proficiently reach that price could cause an asset to be valued inappropriately.

Example of a Daily Trading Limit

Assume, for example, that a lumber futures contract is selling for $3.50, and has a previous day's close of $4. The exchange sets the initial daily trading limit as $3.75 - $4.25.