Some Commodity Futures markets have price limits set on them each day by the Futures Exchange that the product trades on. A price limit states that the market is not allowed to trade higher or lower than these set limits. Each Commodity that has a limit move in their contract has a different value. For example, the Corn market currently has a 40 cent price limit each trading day. This is expandable to 60 cents the proceeding day if the Exchange feels it necessary. Each day the Exchanges will update their websites with these limit moves.
The previous day’s settlement price is used to add and subtract these limits to. If Corn closed at 790’0 yesterday then the next day’s limits would be:
Limit Up = 830’0 (Previous Settle Price + 40)
Limit Down = 750’0 (Previous Settle Price – 40)
Once price trades to the limit prices the market will not be allowed to trade through them. If price trades to the limit up price no buy orders can be executed higher than 830’0. A trader can sell at 830’0 and cause price to come off the limit and move down, but nobody can buy and make price go higher than 830’0. Same on the downside, nobody can sell under 750’0, but they can buy the 750’0’s and make the market rally.
It would seem like if a market like Corn had moved 40 cents ($2,000 per contract) from its previous close that it would be overbought or oversold and you could fade the market. This is where novice Futures traders get in trouble. They do not do their homework first to understand the Futures contract they are trading and they end up getting hit with a large loss because they try entering a market too close to a limit up or down move.
How do markets move up or down 40 cents from the previous day’s close so easily? Simply put – supply and demand is what moves all freely traded markets. We are not talking about supply/demand levels on charts here, we are referring to when there are an excessive amount of buyers or sellers in the market at the same time.
Imagine an order desk on a trading floor taking orders from buyers… Continue Reading
