Daily Trading Limit Definition

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Daily Trading Limit Definition

What Is a Daily Trading Limit?

A daily trading limit is the maximum price range within which an exchange-traded securities may move in a single trading session. The limit up is the maximum amount a price may rise in a single trading day. The maximum permissible price decrease in a single trading day is referred to as the limit down. Trading limitations are instances of circuit breakers (also known as trading bans), which are interventions used by exchanges to assist preserve orderly trading conditions in volatile markets.

To prevent excessive volatility in the derivatives market, daily trading limitations are often implemented, particularly for options or futures contracts. These restrictions are imposed by exchanges to safeguard investors from severe price swings and to deter possible market manipulation.

Key Takeaways

  • A daily trading limit is the maximum amount, up or down, that the price of an exchange-traded securities may move in a single trading session.
  • Securities exchanges establish daily trading limitations to safeguard investors from severe price swings and to deter possible market manipulation.
  • Daily price limitations are also utilized in forex markets, when a country’s central bank establishes limits to avoid currency volatility.

Understanding Daily Trading Limits

Daily trading limitations are price levels set to reduce excessive volatility, which may be damaging to market order, particularly in highly volatile derivatives markets. Their goal is to reduce severe market volatility or manipulation in very illiquid markets, particularly given the high levels of leverage in derivative markets.

  • Once a price limit is achieved, trading may continue at that level, but the price will not surpass the daily trading limit.
  • A locked market occurs when a market achieves its daily trading limit.
  • Other descriptive terms include limit up and limit down, which refer to whether the upper or lower end of the range has been reached.
  • Because prices might become extremely volatile during the expiry month of a derivatives contract (usually futures), daily trading limitations may be eliminated at times.
  • Daily price limitations are also utilized in foreign exchange markets (forex), when a country’s central bank establishes limits to prevent currency volatility.
  Trading Account

As an example, consider the following: Assume a commodity’s daily trading limit is 50 cents per bushel and the previous day’s settlement was $5.00. Traders cannot sell for less than $4.50 per bushel or purchase for more than $5.50 per bushel during the current session.

If either of the daily trading limitations is achieved, this commodity is considered a locked market. It might alternatively be defined as going limit up or limit down depending on whether the upper or lower limit was achieved.

How Daily Trading Limits Impact Traders

Daily trading limitations may have a big impact on trade since prices might possibly move considerably faster upwards or lower if the relevant extreme is reached.

For example, in early 2008, U.S. wheat futures locked in 30-cent daily trading limitations for many consecutive sessions due to significant purchasing from both speculators and grain consumers. The underlying reason of the volatility was an unusually large number of crop losses, which lowered supply. To combat speculative demand, the Commodity Futures Trading Commission (CFTC) tightened daily trading restrictions and exchanges increased margin requirements.

A central bank may set daily trading limitations on its currency in order to reduce currency market volatility.

Currency markets are a common example of central banks imposing daily trading limitations to control any turbulence. The People’s Bank of China, for example, has set a daily trading restriction on the renminbi in the past, allowing it to move within a range as tight as 0.3% and as broad as 2%. Central banks protect these trading limitations by rebalancing their foreign exchange holdings.

  Introduction to Stock Trading

Daily trading limitations may also have an impact on asset prices. Fundamental variables may influence the real value of a futures contract or currency, for example, but an inability to attain that price competently may lead an asset to be valued incorrectly.

Example of a Daily Trading Limit

Assume a lumber futures contract is selling for $3.50 and had a prior day’s closing of $4. The exchange’s first daily trading limit is set at $3.75 – $4.25.

Let’s also imagine it’s been a very dry growth season, and this morning’s newspapers state that a large wildfire has erupted, threatening a key forest growing region. This would cause the futures price to climb and perhaps breach the $4.25 barrier. The exchange may raise the daily limit to $4.60 the next day.

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