Limit down in day trading refers to a large decline in the prices of a financial asset or an index, which triggers a temporary halt in its trading on the exchange. Many exchanges across the world have set thresholds - or circuit breakers - for securities and market indices to keep volatility in the market at appropriate levels. To determine the limit down percentage, the closing price of the prior day is usually - but not always - considered as a reference price point.
What is the SEC limit up - limit down rule?
In April 2011, the Financial Industry Regulatory Authority and national securities exchanges proposed to establish “limit up - limit down” or LULD rules to control extreme market volatility in the U.S stock markets. The proposal was approved on a pilot basis by the SEC on May 31, 2012.
As per the rules, the LULD system restricts trades beyond specified price bands. The reference point for calculating price bands is the average of the preceding five-minute price of the security, and the bands are set at a certain percentage level above and below those reference points. Trading is paused for five minutes when the price touches the price bands without receding back for more than 15 seconds.
How does limit up limit down work?
The SEC has set price bands based on different percentages. The most frequently-used percentage bands are 5%, 10%, 20%, and $ 0.15 or 75%, whichever is lesser. The percentage band that comes into play depends on the tier type of security, its price, and the time period at which the security or future contract touched or breached the band. For example, a 5% band would be applied to Tier 1 securities with a previous close price of greater than $3 if the price touches the percentage band during market open and market hours.
You cannot buy on limit up or limit down because trading in the security gets halted as the price reaches the limit bands. However, you can buy or sell when trading in the security resumes. You might be able to place your orders when the market or security is under a trading halt. However, your orders would be filled, depending on your order type and your price, once trading resumes.
Limit down in the futures market
Limit down and limit up in the futures market are price bands that restrict the prices of futures contracts from moving outside of them. Like stock markets, futures markets also impose these restrictions to keep extreme volatility in prices under check. A limit down restricts price from falling beyond a specific percentage that is determined using a reference price, usually an average of the previous few periods or the previous day’s closing price.
What are stock trading halts?
Stock trading halts are temporary suspensions in trading due to sudden and abrupt price movements up to a certain percentage range. In other words, when the price touches those percentage bands, a market halt is triggered. The percentage bands act as circuit breakers that temporarily suspend trading in the stock.
The SEC has set up rules that govern market-wide trading halts to ensure that markets function in an orderly fashion. For example, a 15-minute halt in trading is triggered when the S&P 500 index declines by 7% and 13% from the previous day’s closing level, before 3:25 p.m ET. If the index declines by 20% from the previous day’s closing level irrespective of the time, trading is halted immediately for the rest of the day.
Similarly, the SEC has set up circuit breaker rules for individual stocks as well. For example, trading is halted for five minutes if the price of certain stocks moves up or down by 5% but does not come back to the original 5% range within 15 seconds. The 5% percentage band applies to stocks that trade above $3 and are either part of the S&P 500 index, the Russell 1000 index, or certain exchange-traded products like ETFs. Other percentage bands or circuit breakers for individual stocks also exist.