Limit up / limit down definition

What is a limit up?

A limit up is the maximum amount that the price of a stock or commodity futures contract will be allowed to increase in a single trading session. Both a limit up and a limit down are used to prevent certain assets reaching excessively high volatility levels.

What is a limit down?

A limit down is the opposite to a limit up, and it sets the maximum amount that the price of a stock or commodity futures contract will be allowed to decrease in a single trading session.

Limit downs seek to prevent panic selling and market crashes. This is because, if more and more traders begin to sell in a panic, the price of the underlying commodity will decrease in line with increased supply and lower demand in the market.

Why was limit up/limit down introduced?

Limit up/limit down was proposed in response to the market volatility experienced on 6 May 2010. This was particularly severe in American markets, with the Dow Jones Industrial Average (DJIA) losing around 1000 points in less than ten minutes. The reason for the drop was uncertain at first, but it was later discovered that it was caused by a $4.1 billion sell order by an American mutual fund.

Investors’ nerves were already jittery on the back of riots in Greece, European countries requesting loans and bailouts, the wider European debt crisis, a general election being held in Britain and the Deepwater Horizon oil spill which affected the oil futures market. The large sell order was the final straw that triggered a mass sell-off.

It’s estimated that over 16 billion futures contracts were sold in a two-minute window, and many stocks experienced heavy declines in their prices. As a result of the crash, the limit up/ limit down boundaries were implemented to prevent similar sell-offs happening in the future.

They were first proposed by a number of national American exchanges and the Financial Industry Regulatory Authority (FINRA) in April 2011. The limits were eventually approved and introduced (at first on a pilot basis) by the Securities and Exchanges Commission (SEC) on 31 May 2012.

Limit up example

For an example of a limit up, we’ll look at commodity futures contracts. For corn futures, the limit up is a $0.30 price movement from the previous close. If the price of corn increases beyond this limit, then trading in corn futures is halted for the rest of the trading day.

This is to stop the price of corn futures – and other commodity futures contracts – from increasing dramatically compared to the price of the underlying asset, which the futures contract represents.

Limit down example

For an example of a limit down, we’ll look at the stock market. There are a series of specific bands in which a stock’s price is allowed to move – taken from a reference price of the stock’s average price in the previous five minutes. These bands are different depending on the ‘tier’ of stock. When talking about limit downs, if the price exceeds the lower band, trading is suspended for a period of time – usually 15 minutes.

For tier 1 – which includes S&P 500-listed stocks, NMS securities and some exchange-listed products with a price greater than $3 – this band is set at a 5% decrease (or increase for a limit up) from the stock’s current price between the hours of 9.45am and 3.35pm.

However, between 9.30am and 9.45am, and 3.35pm and 4pm, the band is set at a 10% decrease (or increase for a limit up) from an average of the stock’s price in the previous five minutes. The full list of specifications for limit ups/limit downs on stocks and other exchange-traded products can be found below.