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Beginner

Limit up. Limit down.

Chris Weston
Chris Weston
Head of Research

Limit down and limit up are a factor many traders have come to know quite well through recent times of volatility in equity markets and the collapse of oil.

Price circuit breakers - or what is commonly known as the ‘limit up’ and ‘limit down’ rule - were implemented to address extreme price moves in equities and the broader equity index. The limit up and limit down rules have been set to allow time for quick reflection and assessment, and to understand if the move is correct and valid.

What instruments are affected?

While most of the attention has been on the limit down rule in equity indices, in reality there are also daily price limits for individual stocks, metals, energy markets, rates and agricultural commodities too.

What are the rules?

The current rules behind daily price limits in equity indices are quite technical. However, during periods of extreme volatility the limit down and up rules may affect your ability to trade in and out of positions, so it’s worth understanding the basics behind the rules. In fast-moving markets and extreme sell-offs and rallies, you may not be able to place a trade at market. While you can always clarify the issue with our award-winning support team, the chances are the index has hit an exchange circuit breaker.

Why are circuit breakers, such as the limit down rule, put in place?

Inspired by the 1987 Black Monday crash and reworked in the wake of the 2010 ‘flash crash’, the limit up and limit down rule was implemented to address extreme price moves in equities and the broader equity index. This was because, aside from a rush of one-sided order flow, an extreme move could be catalysed by a pricing error or market manipulation.

The rules have been set to allow time for quick reflection and assessment, and for the markets to understand if the move is correct and valid.

The mechanics of the limit up and limit down rule

While the rules apply to other US indices (such as the US30, US200 and NAS100), in this case we will use the US500 (S&P 500) as our case study. Like all of our tradeable equity indices, we price the US500 index off the futures market and create a ‘cash’ index by subtracting a ‘fair value’. This model is a blend of expected dividends and interest payments, which would be included into the futures contract price. Given this model, our equity indices are subject to the respective exchange circuit breaker rules.

There are different limits for different periods in the day and these reflect typical liquidity conditions, which can exacerbate the magnitude up or down of the move.

Trading limits when only US index futures markets are open

When outside of normal market trading hours, such as when the cash market is shut, but while S&P 500 index futures markets are trading, the limit by which the US 500 can rise or fall is -/+5%.

However, the percentage change is the change from a reference point calculated at 4:00pm ET the prior day.

In the case of the index going ‘limit down’ through this period, when the market falls 5%, no new sell orders will be filled and traders can only buy.

Price limits during normal (cash) market trading hours (09:30am to 4:00pm ET)

When the exchange is open for normal trading (i.e. the ‘cash’ session), there are three trading limit levels to be concerned with:

Level 1 (7% limit)

  • 09:30am and 03:25pm ET - If the index moves -/+7% through this period, trading is halted for 15 minutes. After which, trade resumes and sellers (buyers) can transact as desired
  • 03:25pm and 4:00pm (market close) Price can move freely through this period, that is until a level 3 halt (-/+20%) is triggered

Level 2 (13% limit)

  • 09:30am and 03:25pm - If the index moves-/+13%, trade is halted for 15 minutes. After this period, trade resumes and sellers (buyers) can transact at the bid (offer)
  • 03:25 and 4:00pm (close) - Price can move freely through this period, that is until a level 3 halt (-/+20%) is triggered

Level 3 (20% limit)

  • If the index moves to -/+20% it will be halted for the rest of the trading session

These rules will change depending on the market in question, but in periods of extreme moves in price the prospect of the market hitting a trading limit is high, so it’s good to be aware of the market limits.

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