Cap-and-trade, also known as carbon trading or emissions trading, is an approach to reducing greenhouse gases using the marketplace. It exists in various worldwide locations such as the European Union, but not the in the U.S., although there is cap-and-trade in a few states and some on a voluntary basis.
The “Cap” refers to the limits that are placed on a pollution emitting entity such as a power plant. They are given permits to pollute up to that limit. The “Trade” refers to the practice of buying or selling such permits. Thus, there is an overall cap in place, but companies are allowed flexibility within that cap. The permits are bought and sold on exchanges set up for that purpose.
This is similar to the cap and trade program enacted by the Clean Air Act of 1990, which reduced the sulfur emissions that cause acid rain, and it met the goals at a much lower cost than industry or government predicted.