25. Daily Trading Limits (Stocks and Commodities)

No governing authority should be allowed to prevent the implementation of maximum daily trading limits (based on range of price movements for a single day) when requested by either a securities or commodities exchange, or even perhaps when requested by the original sellers of a security, in which case any trading limit would apply to securities of that single company. As a general rule, these trading limits should range between 5-10% of the value of the security or contract. A smaller percentage would trigger limits on trading too often, thus interfering a little too much into the operations of a free market. A larger percentage would tend to defeat the purpose of such a system, allowing too much ‘damage’ into the market before forcing a market-wide pause in trading.

Such a system would operate as follows. Let’s assume that a stock’s closing price is at $100 per share. Assuming that a 10% limit was set for that stock, on the next trading day the price of that stock would be allowed to trade anywhere from between 90-110, without any penalty or restrictions. However, let’s assume that negative news pushes that stock lower so that it hits the 90 level. At that point, the exchanges would prevent trading at any price lower than 90. Trading at or above 90 (up to 110) would be allowed throughout the rest of the trading day without restrictions of any kind. If the stock holds at 90 until the close of trading that day, it would mean that trading for the next day would be allowed only in a range that is + or – 10% of 90, which is from between 81 and 99. For penny stocks trading at $5 or less, perhaps there should be much less restrictive trading limits or no limits at all. Governments should encourage the use of such daily price range limits so that markets will be afforded a certain degree of protection from wildly swinging prices resulting from information which in the end may be seen as untrue or exaggerated. The extra time provided by these limits could be used by traders to further analyze news/information, likely making pricing activity resulting from false news less severe than would otherwise be the case.

Though this would also work to limit moves resulting from beneficial news, the concept of a speed limit placed on price moves would act to moderate a wildly fluctuating market. In the end, prices will reflect the true value of the underlying, but trying to reestablish that equilibrium through the use of moving upper and lower pricing channels is an attempt to tame a market that would otherwise experience greater volatility, generating slippage losses that traders would otherwise be less able to predict.

The ultimate solution to this problem of highly volatile markets and market conditions is not trading restrictions, like the trading limits delineated above, but the dominance of long term traders and market players who know how to react to news, and the creation of a market trading environment that is less amenable to yielding profits on tiny moves of stock prices. For example, the imposition of a standard sales tax on each stock transaction would automatically and significantly reduce the profit potential of day traders and other short-term investors who are the types of traders most often responsible for precipitating drastic price moves which in turn trigger a succession of automated and institutional behavior in the same direction. To encourage trading behavior more in harmony with actual facts, short-term trades, whose traders base their trading decisions purely on price, need to be tempered.

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