Limit down describes a significant decline in the price of a futures contract or stock that triggers trading restrictions based on exchange regulations. These limitations aim to mitigate unusual volatility and provide traders time to process market-moving news.
Key Takeaways
- Definition: Limit down is a decline in the price of a futures contract or a stock sufficient to trigger trading restrictions.
- Trading Halts: Restrictions can range from a five-minute halt to lasting the remainder of the session. In some scenarios, trading may continue but not at prices lower than the limit down.
- Purpose: It attempts to stabilize the market by dampening sudden price movements.
- Circuit Breakers: Broader market-wide circuit breakers are triggered by significant declines in major indices like the S&P 500.
How Limit Down Works
Trading curbs, including limit down halts, are designed to prevent self-reinforcing plunges and surges in market prices spurred by other traders’ behavior or emergent information. Once the limit down threshold is reached, trading restrictions commence, with varying durations and rules based on the specific regulations in place.
Futures Market Examples
The London Metal Exchange enforced a limit down rule in March 2022 to curb price volatility in nickel futures, capping the permissible decline from the previous closing price.
Similarly, CME Group mandates a two-minute trading pause for energy futures if prices move up or down by more than 10% within an hour. For lumber and agricultural products, CME adjusts the limit down in dollar terms, twice annually, reflecting the average price shifts over the preceding 45-day period.
U.S. Stock Market Circuit Breakers
In the U.S. stock markets, the following price drop thresholds initiate trading pauses:
- A 7% drop from the prior day’s close before 3:25 p.m. ET initiates a 15-minute pause.
- A 13% drop before 3:25 p.m. ET also triggers a 15-minute halt.
- A 20% drop from the prior day’s close at any time results in a trading halt for the entire trading day.
In March 2020, U.S. stock markets experienced multiple 15-minute halts following sharp 7% intraday declines in the S&P 500 spurred by the COVID-19 pandemic.
Individual Stocks and Limit Up-Limit Down
The Limit Up-Limit Down rule, active since 2012, seeks to moderate excessive volatility in individual stocks using trading pauses ranging from 5 to 10 minutes.
For stocks within the S&P 500, the Russell 1000, and certain exchange-traded products, any price move of 5% above or below the previous five-minute average price prompts a trading pause. For other stocks priced above $3, a 10% move triggers a trading halt.
This regulation, alongside the S&P 500 circuit breakers, were implemented after the 2010 flash crash, wherein the S&P 500 plummeted nearly 9% intraday on May 6, 2010.
Related Terms: limit up, trading curb, market volatility, circuit breaker, S&P 500, futures market.
References
- CME Group. “Product Examples for Daily Price (Trading) Limits”.
- CME Group. “Understanding Price Limits and Circuit Breakers”.
- LME. “Changes to Daily Price Limits for Nickel”, Page 1.
- CME Group. “Grain, Oilseed, and Lumber Price Limit FAQ”.
- Investor.gov. “Stock Market Circuit Breakers”.
- Securities and Exchange Commission. “Notice of Filing and Immediate Effectiveness of Proposed Rule Change to Extend the Market-Wide Circuit Breaker Pilot to April 18, 2022”, Page 4.
- Limit Up Limit Down. “Plan”.
- U.S. Commodity Futures Trading Commission, U.S. Securities and Exchange Commission. “Findings Regarding the Market Events of May 6, 2010”, pp. 1-8.
