What Is Limit Up?
Limit up is the maximum amount a price is permitted to increase during one trading day. The term is often used in relation to the commodities futures markets, where regulators seek to prevent volatility from reaching extreme levels.
Limit down, by contrast, refers to the maximum permitted decline in one trading day. Both limit up and limit down prices are examples of circuit breakers—interventions employed by exchanges to help maintain orderly trading conditions.
- The limit up price is the maximum price a commodity futures contract is allowed to rise within one trading session.
- It is put in place to prevent extreme volatility or manipulation of futures prices.
- Limit up prices are adjusted on a daily basis by exchanges, and have led to reduced volatility in recent years.
Understanding Limit Up
A limit up price is the maximum daily price movement permitted for a futures contract. The exchange will monitor trading of all futures contracts and automatically halt trading in a contract if its limit up price is reached. Different futures contracts will have different price limit rules, so it is perfectly possible for some parts of the market to be halted while other trading activities continue as normal.
If a price rises above its limit up level, the exchange can either halt trading in that security or choose to raise the limit up and permit further trading.
The rationale behind imposing limit up prices is to help smooth out the volatility of the commodity futures markets. According to data from the Chicago Mercantile Exchange (CME), this effort has been largely successful, with fewer halts in trading being recorded in recent years.
Another advantage of using limit up prices is to make it more difficult for unscrupulous traders to manipulate the market, such as by flooding the market with a large number of highly-priced orders in an attempt to artificially bid up the price.
Importantly, the use of limit up prices does not prevent traders from entering orders to trade futures at levels above the limit price. However, these traders may need to wait until trading in these futures is allowed to resume before their orders will be filled. Investors wishing to place trades above the limit up level, may wish to use good 'til canceled (GTC) or good 'til date (GTD) orders to accommodate these potential delays.
Real World Example of Limit Up
Commodity exchanges such as the CME publish daily price limits on their website. Each day, the exchange recalculates what the limit up and limit down prices should be for each contract.
For example, as of October 2020, the limit up price for ethanol futures contracts was set at $0.30 per contract. Importantly, these price limits are listed in the month in which the contracts expire, in order to allow room for the futures price to converge with the underlying spot price of the commodity.