A limit move is a restriction on the maximum increase or decrease in the trading price for a security or derivative in a trading session. This is designed to prevent price bubbles caused by speculative trading activities as well as precipitous declines associated with investor panic. It is set by an exchange, which considers current market conditions and the history of a given security when determining the appropriate limits to set. The basis price and definition of a “session” can depend on the exchange; it might, for example, extend a limit move over a whole day of trading and base the price on the closing price from the previous day.
Also known as a maximum price fluctuation or price limit, this ensures that prices stay within a specific range. For example, a commodities exchange might decide to put a limit move on wheat at $0.50 US Dollars (USD). If wheat is trading at $4.50 USD, it can drop as low as $4.00 USD or rise as high as $5.00 USD, but it can’t trade at values outside this range. The limit move keeps the price stable, and prevents a rush of speculative trading activity that might artificially inflate or devalue the commodity.
When the limit is reached, traders reach a state of limit lock. Trading can grind to a halt because there is a mismatch in terms of buyers and sellers and because the price can’t go any further, people may be reluctant to make the first move. In some cases this may be desirable, as it allows a security or derivative to cool off before trading resumes. Limit lock can also create problems with a market that result in sluggish performance, and an off day. Policy makers at an exchange need to carefully balance risks when they decide on a limit move.
Having a daily trading limit can create some stability in a volatile market. Traders working under an up or down limit know that prices can’t pass beyond that specific point on that day; this may slow down trading and give it a chance to stabilize. When trading reopens for the following session, people can push the limits again to see if trading in that security or derivative is still as robust. They avoid large losses that might be created with limits to keep pricing in check and within reasonable boundaries.
Information about any limit move policy is available in the rulebook of an exchange. This document goes over policies for trading, including the rules people need to follow when participating in trades and preparing to join the exchange. Some exchanges set dress codes and behavior standards people must meet in order to be allowed to trade on the floor, in addition to the legal and ethical policies designed to keep the exchange functional.