John Wiley & Sons has a fairly comprehensive digital library of trading publications, including the histories and breakdowns of a lot of rules and regulations. In a research article on commodity price limits, Rajkumar Janardanan, Xiao Qiao and K. Geert Rouwenhorst state the following...
“Price limits in commodity markets have a long history that goes back to the first commodity futures exchange in the 18th century: The Dojima rice exchange in Japan curbed the price movements of rice futures during a time when prices were falling (Moser, 1990; Schaede, 1989). The stated purpose was to avoid excess volatility.”
In a nutshell, it’s the simplest way to explain the purpose of price limits; “to avoid excess volatility.”
Here’s What Our Coach’s Have To Say
In the wake of the 1987 stock market crash, the Brady Commision was set up to study what went wrong and make recommendations on how to improve future market performance.
Aside from new regulatory standards and margin requirements, the Brady Commission also introduced a system of Circuit Breakers in order to control financial risk in the event of another possible market crash.
These Circuit Breakers played a significant role back in March when Covid-19 fears created wave after wave of panic selling in the stock market. Overnight price limits and intraday breaker levels being hit led to multiple instances of trading halts during this highly volatile period.
It’s difficult to speculate how much worse the damage could have been if there weren’t a system of price limits set in place to protect against an all out crash, but it’s easy to assume it could have been disastrous.
Be Aware Of Price Limits
No one wants to be caught on the wrong side of a limit move. Situations like that can be catastrophic for smaller retail traders. When prices are locked at limit levels, liquidity simply ceases to exist and the probability of being able to exit a losing position drops to near zero; meaning you will have to take your chances again the next day.
You can find the daily limits for the markets you’re trading on the CME Price Limits page.
In an effort to protect our firm and our traders, Topstep has recently introduced a new rule involving trading around price limits. You can learn more about it by visiting our Help Center.