Futures exchanges monitor and control the
volatility
of the price fluctuations in the futures markets. For most futures contracts, the exchange where it's traded establishes a daily price limit that prevents the price of any particular futures contract from rising or declining beyond a preset limit. In this lock limit system, when the high or low price limit is reached, trading is stopped, or locked.
The price limit is set in relation to the
closing price
on the previous trading day and specifies an amount in dollars or cents of how much higher or lower the price can move. If gold was trading at $350 per troy ounce the previous day, the current day's price limit might be $35. No trades could be executed at prices above $385 per troy ounce, or below $315 per troy ounce. Daily price limits are not permanent and exchanges may change them. During the expiration, or
delivery month
for a futures contract, price limits are often lifted, causing extreme volatility for the last trading month of a contract.
The risk to investors of daily price limits is that they cannot always liquidate their position and when the market re-opens the stabilized price may be well above or below what the investor needs to profit — or avoid loss — with an offsetting contract.
Stop orders and daily price limits Stop orders
specify a price at which a broker should buy or sell a particular contract. When the set price is reached, the broker's obligation is to execute the trade at the best available price. In practice, in a volatile market, the price at which the trade is executed may be well above or below the set price. In other cases, with fast-rising or fast-falling prices, the stop order price may even pass too quickly to be acted upon and the lock limit system may prevent further trading in the contract. When trading begins again, there is a strong likelihood that the previous price trend will continue, increasing the gap between the stop order price and the actual price, which means that the trader has not prevented a loss.
