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 permitted to change 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 happening north of one trading day. Trading limits are instances of circuit breakers (otherwise called trading curbs) — mediations employed by exchanges to assist with keeping up with orderly trading conditions during tempestuous markets.
Daily trading limits are many times utilized in the derivatives market, particularly for options or futures contracts, to limit extreme volatility. Exchanges impose these limits to shield investors from extreme price developments and to beat likely manipulation inside the markets down.
Seeing Daily Trading Limits
Daily trading limits are price ranges laid out to diminish exorbitant volatility that can be unfavorable to the orderly working of markets, particularly in highly unpredictable derivatives markets. Their purpose is to bring down extreme market volatility or manipulation in generally illiquid markets, particularly since derivative markets are described by their high levels of leverage.
- When a price limit has been reached, trading can in any case go on at that limit yet the price won't cross the price set for the daily trading limit.
- A market that arrives at its daily trading limit is alluded to as a locked market.
- Other descriptive monikers incorporate limit up or limit down, contingent upon whether the upper or lower end of the reach has been reached.
- On occasion, daily trading limits might be taken out during the expiration month of a derivatives contract (ordinarily futures), since prices can turn out to be particularly unpredictable.
- Daily price limits are utilized in the foreign exchange markets (forex) too, by which a country's central bank imposes limits to reduce the volatility of its currency.
Here is a speculative model: Suppose the daily trading limit for a specific commodity is 50 pennies for every bushel and the previous day's settlement was $5.00. In this case, traders can't sell for under $4.50 or buy for more than $5.50 per bushel during the current session.
On the off chance that both of the daily trading limits were to be reached, this commodity would be considered to be a locked market. It would likewise be depicted as having gone limit up or limit down in view of whether the upside or downside limit was reached.
What Daily Trading Limits Mean for Traders
Daily trading limits can essentially influence trading given that prices might possibly move higher or lower significantly more rapidly once the individual extreme has been reached.
For instance, U.S. wheat futures locked up 30-penny daily trading limits in mid 2008 for several back to back sessions in the midst of heavy buying from the two speculators and grain users. The underlying reason for the volatility was driven by an extraordinary 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 stifle speculator demand.
A central bank sometimes imposes daily trading limits on its currency to try and control unsteadiness in the currency markets.
Currency markets are a famous illustration of daily trading limits imposed by central banks to control any insecurity. In the past, for instance, the People's Bank of China has imposed a daily trading limit on the renminbi , permitting it to move inside a band as narrow as 0.3% and as a wide as 2%. Central banks guard these trading limits by changing the organization of their foreign exchange reserves.
Daily trading limits can likewise influence asset valuations. Fundamental factors might affect the true value of a futures contract or currency, for instance, yet a powerlessness to capably arrive at that price could make an asset be valued improperly.
Illustration of a Daily Trading Limit
Expect, for instance, that a wood futures contract is selling for $3.50, and has a previous day's end of $4. The exchange sets the initial daily trading limit as $3.75 - $4.25.
We should likewise say that it has been an especially dry developing season, and morning titles on this day report that a monstrous fierce blaze has broken out and compromises a prime forest developing area. This event would make the futures price rise and maybe try to pass the $4.25 limit up. The next day the exchange might extend the daily limit to $4.60.
- Daily trading limits are imposed by securities exchanges to safeguard investors from extreme price developments and beat likely manipulation inside the markets down.
- Daily price limits are utilized in the forex markets too, by which a country's central bank imposes limits to reduce the volatility of its currency.
- A daily trading limit is the maximum amount, up or down, that an exchange-traded security's price is permitted to move throughout a single trading session.