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.