Limit up and limit down explained
With volatility gripping global markets, US stock futures hit limit down on Monday and limit up on Tuesday. What does limit down and limit up mean and how do they impact trading?
Limit up explained
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.
Limit down explained
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.
According to revised rules from the SEC from 2012, market-wide circuit breakers are activated at the following levels versus the previous day’s close:
- A drop of 7% (Level 1)
- A drop of 13% (Level 2)
- A drop of 20% (Level 3)
If the market declines, triggering a Level 1 or Level 2 circuit breaker before 3:25pm ET, trading will be halted across the market for 15 minutes. Beyond 3:25pm will not halt trading. If a Level 3 is enacted with a 20% drop, trading will be halted for the rest of the day’s session.
Due to today’s market volatility, S&P futures have hit limit up. The break through the threshold means that buying the market is suspended.
Limit up (like today) means that buying is suspended, while limit down (like yesterday) means selling is suspended. The CME Group says 'Equity price limits are downside limits during U.S. trading hours, with hard upside and downside limits of 5% during non-U.S. trading hours.' When the out-of-hours session ends and it turns into the main session, the circuit breaker become 7% instead of 5%.
Today at IG therefore, if a market is in limit up, you would only be able to sell positions, whether open or close, through phone dealing.
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