DEFINITION of 'Daily Trading Limit'

A daily trading limit is the maximum gain or loss on a derivative contract, such as an option or futures contract, that is allowed in any one trading session. The limits are imposed by the exchanges in order to protect against extreme volatility or manipulation within the markets.

BREAKING DOWN 'Daily Trading Limit'

Daily trading limits – or daily price limits – are price ranges established for derivative contracts, such as futures or options. Once a limit has been reached, the derivative can’t be traded at any higher (or lower) price until the next trading day. The goal of daily trading limits is to reduce extreme volatility or manipulation in relatively illiquid markets, especially because derivative markets are characterized by high levels of leverage.

For example, a daily trading limit for a grain might be $0.50 per bushel and the previous day’s settlement may be $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. A market that has reached a daily trading limit is said to be a “locked market” and/or either “limit up” or “limit down” depending on whether the upside or downside limit was reached.

In some cases, daily trading limits may be eliminated during the contract expiration month since prices can become especially volatile. Traders may want to avoid placing trades during these times since volatility can become quite significant.

How Daily Trading Limits Impact Traders

Daily trading limits can have a big impact on trading since prices are able to move higher or lower much more quickly.

For example, U.S. wheat futures locked up 30-cent daily trading limits back in early-2008 for several straight sessions amid buying from both speculators and grain users. The underlying cause of the movement was driven by unusual crop losses that cut supplies. Some exchanges responded by increasing daily trading limits to enable the commodity to reach market prices, while attempting to cool speculators by increasing margin requirements.

Currency markets are another popular example of daily trading limits imposed by central banks to control volatility. For instance, the Chinese renminbi​ had a daily trading limit of 0.5% against the U.S. dollar to control any volatility. Central banks would defend these trading limits by changing the make-up of their currency reserves. These efforts may have helped avoid significant volatility, but opponents argue that they result in an imbalance in the market.

Daily trading limits may also have an impact on asset valuations. For example, fundamental factors may influence the true value of a futures contract or currency, but an inability to efficiently reach that price could create a mis-valued asset.

The Bottom Line

Daily trading limits – or daily price limits – are price ranges established for derivative contracts, such as futures or options. These limits can have a big impact on trading since prices are able to move higher or lower much more quickly. Traders should understand markets where these daily trading limits exist and be aware of months when they may not apply.

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