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Daily trading limits are the total amount that a given market is allowed to rise or fall during the course of any trading day. A daily trading limit is usually associated with an options or commodities market. The application of this type of limit on the trading activity helps to maintain some degree of stability for the marketplace, even if external factors exist that could potentially undermine that market.
Using a daily trading limit also serves as a means of measuring overall market activity during the trading period. If the trading is robust and reaches the upper level of the daily trading limit, the market is said to enjoy what is known as an up-limit day. Conversely, if the trading is somewhat stagnant and does not rise anywhere near the daily trading limit, the market is understood to have experience a down-limit day.
Because the daily trading limit is in place to help maintain stability in a given market, reaching the maximum limit for the day requires immediate action. When the maximum limit is attained, the phenomenon is referred to as a locked market. At this point, trading on the market will temporarily halt on any commodities or securities that have exceeded the daily trading limit. Depending on the nature of the trading, it is also possible that trading on those commodities and securities may close for the remainder of the trading day.
In addition to use in commodities and options markets, a daily trading limit is sometime employed with currency trading as well. As with the other markets, the main function of the daily trading limit in foreign exchange markets is to maintain some degree of stability. With currency trading, the method is usually to identify a specific allowed percentage of trades of one currency against another, based in part on the current rate of exchange between the two currencies. If the trading approaches the threshold of the daily trading limit, the action is called a limit up. In the event the trading percentage does not come anywhere near the daily trading limit, the activity is referred to as a limit down.
While a daily trading limit may be imposed for bonds or stocks, the concept of keeping trading with certain limits is more often employed with markets where options, futures, commodities or currency is actively traded. Part of this is due to the huge volume of leverage that is often used in those markets to make trades.