This question can be inviting under the right circumstances. However, in the Futures markets, it could mean you are in for a large move against your position when the market reopens in the morning. Futures Exchanges created rules that will allow certain Futures contracts to trade a limited amount above or below yesterday's close. Once these pre-determined amounts are traded to the next trading day, the market ceases trading in that direction. For example, if you happen to be short the market and the market goes Limit up, you will be staying the night in the market even if you don't want to. The reason I say you can expect a large move against your position in the morning is because markets go to these Limits because of excessive supply and demand. Once the market closes at these Limit moves, fear becomes one of the motivating factors to get out of this trade on the next day's open. In this example, if traders, who are short the market, are stuck in this Limit up move, they will have to buy MOO (Market on Open) orders stacking up before the market opens. This will cause a very big gap the next day due to the imbalance of buy and sell orders.

A Limit is the maximum amount the price of a Commodity Futures contract can change during any particular trading day, up or down, from the previous day's closing price. Limits are set by the Futures Exchanges that the products are traded on.

Here are a few of the markets that do have daily price limits:

This is not a complete list. Please visit the Futures Exchanges websites where your Commodity trades for more information.

There are mixed opinions as to whether these Limit moves serve their purpose. The Futures Exchanges created these many years ago to help protect small investors and to create time for the market participants to rethink the event that caused this extreme move and come back the next day with calmer and cooler heads to trade this market.

Some traders feel that if there were no Limits in the market, then there would be no fear of being stuck in the market against the trader's wishes. Removing this fear would help by not causing traders to panic when prices approach these Limit levels. The jury is still out on whether the Futures Exchanges will ever get rid of these Limit moves. Many markets that used to have Limits (Treasury Bonds, Gold, Currencies, etc) now trade without them. The 30-Year Treasury used to have a 3-00 daily limit until it was removed in the late 1990's. We used to trade to these Limits on occasion and watch the next morning as the 30-Year would gap up or down based on the fear in the market from these Limits. Since the Limits have been removed, it is very rare to see the 30-Year trade even remotely close to the old 3-00 daily Limit. The same can be said about the other markets that no longer have Limits. Seems that if the markets are free to trade without any bands or restrictions, then they seem to self regulate their volatility.

The markets that currently have these daily price Limits are usually Futures contracts with smaller daily volume. This can cause a liquidity issue when major events happen in a Futures market. So for now, the Limits remain on certain contracts while they have been removed from others. Kind of like the difference between the taste of a free range steer and steer from a feedlot; one is just naturally going to taste better.

One of the steps that the Exchanges are doing is to incorporate something called a Circuit Breaker instead of a daily Limit for the price. These were established after the 1987 stock market crash. Where as a Limit will halt trading in that direction for the entire day, a Circuit Breaker will halt trading usually for a short period of time and then resume trading and the market is free to go even further in the same direction. For example, the CMEGroup limits the S&P's and Nasdaq to 5% declines from the previous day's close during the extended trading hours electronic session only. This means that the market can only fall this amount and no lower. Then once the trading floors open, the markets are free to fall more. Stock indexes only have these Circuit Breakers and Limits to the downside except during the extended trading hours when there is an upside as well as downside Limit. During the regular trading hours, the market is free to rally as much as demand will carry it.

At the end of every quarter (3 months), the CMEGroup adjusts these limits and post new limits for the next quarter. So it is a good idea to check on these Limits quarterly to make sure you are aware of any changes. Figure 1 shows these Limits and Circuit Breakers for some of the Stock Indexes.

 

I have seen a few of these Circuit Breakers hit over the past few years and each time we hit the 10% Limit down the market bounces off that low and rallies strongly. There seems to be so many value investors that when they see a market this oversold, they rush in with buy orders. The Circuit Breakers are designed to stop the trading to the downside for about an hour and then resume trading. The market cannot seem to stay down 10% for very long. Once the market trades to these 10% Limits, the Circuit Breakers are designed to halt prices from going any lower. The market is free to rally from these levels, but cannot trade below them for one hour. After the hour is up, the market could trade lower until it hits the next level of 20%; at this point, another one hour halt to prices declining takes effect.

These Circuit Breakers are not limited to the Stock Indexes. The Cocoa market is demanding Circuit Breakers after a huge 11% price drop in seconds on March 1, 2011 (largest in history) occurred. Much of this was blamed on high frequency traders, but reports are showing that they only do about 10% of the activity in soft commodities on the ICE Exchange.

The Energy markets have Circuit Breakers also. On May 1, 2011 the gasoline contract fell its daily Limit and activated a Circuit Breaker. When one component of the Energy sector (oil, gas, heating oil or Natural Gas) hit their Limits, the entire complex stops trading for 5 minutes. Before they resume trading, all the Limits are doubled and price is allowed to trade again until the next Limit or the market closes.

 

By knowing if the market you are trading has a Limit move or a Circuit Breaker, you
can be better prepared for how to trade when price arrives at these critical points. A Circuit Breaker can be much more forgiving than a Limit move in markets like the Grains or Livestock markets.

"Good ideas are not adopted automatically. They must be driven into practice with courageous patience." Hyman Rickover