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The lower limit is the maximum decrease in price a commodity futures contract can experience in a single trading day before trading is suspended. It provides protection to investors and allows for decision-making during catastrophic events. It also offers opportunities for buying at a discount. Employing strategies based on the lower limit can produce benefits.
Sometimes referred to as the daily trading limit, the lower limit is the largest decrease the price of a commodity futures contract can experience in a single trading day before trading in that contract is suspended. In some settings, the term is also used to identify the maximum amount of contract price increase that can be achieved in a single trading day, although this application is much less common. In general, the idea of the lower bound is to avoid extremes that could possibly undermine the integrity of the investment. Should the price move away from the down limit before the end of the trading day, there is a good chance that that investment will be allowed to start again, rather than waiting until the next day.
One of the reasons behind setting trading limits is to provide some checks and balances in a market, even when extreme events occur. With a lower bound, the futures market is trying to protect itself, and as a result, its investors experience what could be dire consequences as a result of unforeseen events. Since the effects of some type of catastrophic market event can take several days to impact a futures contract, investors have the opportunity to make decisions about what to do with their holdings. At the same time, trade limits provide a window of breathing room, making it possible for prices to plummet only to the extent that the after-effects of the crisis manifest. In a few days, as the market begins to recover, trading in futures contracts may resume and the upward and proper price movement may continue at a more balanced pace.
While a lower limit offers some degree of protection to investors, it also offers some opportunities for those who choose to buy the contracts at low prices just before the freeze is implemented. The assumption is that they can benefit from buying at a discount by holding the futures contracts through the halt of trading, and hopefully emerge with an asset that can be sold at a profit a few days or weeks into the future. Understanding what kind of effect various events will have on the underlying assets of the futures contract, whether a lower limit is expected to be reached, and how to respond to get the most benefit from the situation is essential if the investor wants to avoid losses.
The lower limit is one of many trading limits that investors can use to protect their financial positions and possibly even implement a strategy that will serve them well down the line. Knowing the lower bound often makes it easier to develop contingency plans in advance, based on projections of what would happen if the market moved in a certain direction within a specified period of time. Employing strategies of this type makes it easier to respond to the pending implementation of a lower bound in a way that ultimately produces benefits that would otherwise have been lost.
Smart Asset.
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