Banding keeps markets in an orderly range.
Price banding is an exchange mechanism that subjects all orders to price validation and rejects orders outside the given band to maintain orderly markets. Bands are calculated dynamically by each exchange for each product based on the last price, plus or minus a fixed band value. Thus, if markets quickly move in one direction, the price bands dynamically adjust to accommodate new trading ranges.
Let's say we have an S&P 500 E-mini futures contract (ES) with the following parameters:
Base Price: $4,000 (Previous day's settlement price)
Price Band Range: ±5% from base price
Upper Price Band = $4,000 + (5% × $4,000) = $4,200
Lower Price Band = $4,000 - (5% × $4,000) = $3,800
Here's how it works in practice:
1. During Trading:
- If someone tries to place a buy order at $4,250 → REJECTED (above upper band)
- If someone tries to place a sell order at $3,750 → REJECTED (below lower band)
- Order at $4,150 → ACCEPTED (within bands)
2. Circuit Breaker Effect:
- If price hits $4,200 → Trading pauses
- If price hits $3,800 → Trading pauses
- Exchange reviews market conditions before resuming
3. Daily Reset:
- At end of trading day, new settlement price is established
- Next day's bands are calculated based on new settlement price
- Example: If new settlement is $4,100
* New Upper Band = $4,305
* New Lower Band = $3,895
This mechanism helps:
- Prevent erroneous trades ("fat finger" errors)
- Limit extreme price volatility
- Protect against market manipulation
- Provide orderly price discovery
Different contracts have different band widths based on their typical volatility - for example, more volatile contracts like Bitcoin futures might have wider bands than Treasury futures.