DEFINITION of ‘Limit Down’
The maximum amount by which the price of a commodity futures contract may decline in one trading day. Limit down also refers to the maximum decline permitted in individual stocks on certain exchanges before trading curbs kick in. The limit is generally set as a percentage of the market price of the futures or stock, and occasionally as a dollar amount. These limits were introduced to counter unusual market volatility and prevent panic-driven selling.
BREAKING DOWN ‘Limit Down’
Some futures markets close trading of contracts when the limit down is reached; others allow trading to resume if the price moves away from the day’s limit. If there is a major event affecting the market’s sentiment toward a particular commodity, it may take several trading days before the contract price fully reflects this change. On each trading day, the trading limit may be reached before the market’s equilibrium contract price is met.
In June 2012, the Securities Exchange Commission approved two proposals put forward by the national securities exchanges and FINRA to counter unprecedented volatility in individual stocks and the U.S. stock market. One proposal aims to establish a “limit up-limit down” mechanism that will “prevent trades in individual stocks from occurring outside of a specified price band, which will be set at a certain percentage above and below the average price of the security over the immediately preceding five-minute period.” For example, the percentage level for liquid stocks, such as those in the S&P 500, will be 5%, and 10% for other listed securities. These proposals are expected to be implemented by February 4, 2013.