Read further to better understand how the limit-up limitation works in the investing world and how it protects consumers and the market.
Definition and Example of Limit Up
Limit up is the upper end of the price range in which the price of a security can move within a day under the SEC’s Limit Up-Limit Down rule. This rule was created by the SEC in 2011 to allow the regulators to manage extreme volatility in the U.S. equity markets. The SEC’s goal was to prevent trades that exceed established daily price bands. These price bands are determined during a specific day’s trading hours and affect individual exchange-traded funds (ETFs) and stocks. The same principle also applies to commodity futures. The limitations protect futures contracts from jumping in price too high or low because of unexpected events that cause major commodity price changes. You may also hear the term “limit up” used in the context of the Limit Up-Limit Down Circuit Breaker (LULD). The LULD is a single stock circuit breaker that serves as a market volatility moderator. How does the LULD accomplish this? By preventing the large sudden price movements that the Limit Up-Limit Down Rule prevents.
How Limit Up Works
Limit up, as well as limit down, affects all National Market Systems stocks, which are the majority of stocks listed on an exchange. Non-convertible and convertible preferred stock are also affected by the Limit Up-Limit Down rule. The price band set for a security determines where the limit up stops a price increase. If a specific stock’s price moves to the price band but fails to go back to the original price band within a matter of just 15 seconds, the stock stops trading for five minutes. Most frequently, price band percentages are set at 5%, 10%, 20%, or the lesser of $.15 and 75%. The percentage amount chosen will depend on what the price of the stock is, what time of day it is, and if the stock is designated as a Tier 1 or Tier 2 NMS stock. For reference, the S&P 500, the Russell 1000, and certain exchange-traded products are Tier 1 NMS stocks. NMS securities, with the exception of rights and warrants, are classified as Tier 2 NMS stocks. This is how these factors can influence what percentage is chosen for a stock’s price band:
5% band—Tier 1 stocks10% band—Tier 2 stocks
If a securities has prices of less than $3.00, then the percentages are doubled during the opening and closing periods.
What It Means for Individual Investors
Daily price bands within which securities can trade are ways for regulators and exchanges to protect investors against extreme volatility within a single trading session. For the most part, long-term investors need not worry about short-term volatility in securities. Want to read more content like this? Sign up for The Balance’s newsletter for daily insights, analysis, and financial tips, all delivered straight to your inbox every morning!
