What is a Limit Move
The limit move acts as a circuit breaker and is the maximum amount of change that the price of a commodity futures contract is allowed to undergo in a single day. This amount gets its basis from the previous day's closing price. Trades are not permitted to rise above or drop below the set price once reaching the limit. The exchange where the futures contract trades will set the limit move.
BREAKING DOWN Limit Move
Limit moves exist on the futures exchange to prevent excessive volatility in a particular market. Several factors can prompt market volatility or extreme changes. The most common are changes in response to the weather, results of the supply and demand report, and intense market uncertainty. Today, only a few commodities have limit move controls such as those for grains, livestock, and lumber.
If a particular contract contains control limits, the information will appear on the specification sheet on the exchange where it trades. The limit move does not halt trading of the commodity but instead suspends price moves. Traders may not buy above the high limit and cannot sell below the low limit.
The daily controls will use the previous closing price and add an initial limit to that price. The initial limit will reset the bar, allowing the price to advance beyond the last close while it will also raise the bottom price. If a market should try to exceed the limit in place, the following day the exchange may expand the limit move, giving the commodity more room to run. Of course, this will also move the bottom price level up. The opposite may also happen where the market pushes the price below the bottom price. Once the commodity begins closing at a rate that is neither the limit high nor the limit low, and the price will return to its original initial limit.
Example of Limit Move
For example, assume that a lumber futures contract is selling for $3.50, and has a previous day's close of $4. The exchange will set the initial limit at $4.25. During a particularly dry growing season, a wildfire has broken out and threatens a prime forest growing area. This event would cause the futures price to rise and perhaps try to pass the $4.25 control point. The following day the exchange may expand the limit to $4.60.
Other Limits for Commodity Futures
Other limits which effect a commodity's futures contract are:
- A position limit is a preset level of ownership or control which a trader cannot exceed. Most position limits are set too high for an individual trader to reach, but they provide stability in financial markets.
- The exercise limit sets restrictions on the number of single class of contracts that a person or company may exercise within a fixed period. This action avoids allowing one entity to corner or impact the market of the underlying security.
- A daily trading limit is a maximum amount that an investor may profit or may lose on a derivative contract in any one trading session. These limits occur because most futures trading uses margin.
- The lock limit which happens when the contract price of a commodity instrument moves beyond an allowable limit stopping trading for the day.
- A limit Up is the maximum amount the price of a commodity futures contract may advance in one trading day.
- Conversely, the limit Down is the most the price may decline in one trading day.