The proverb ‘To err is human’, which means, ‘it is normal for human beings to make mistakes’, has not spared the global stock markets too, despite high-end technologically advanced risk mitigation systems in place. Over the years, market players have established various ways to discourage and even cancel any abnormal orders.
Whenever a stock market behaves erratically, an impulse reaction among most market players is that it may just be a sell-off by foreign investors or global political tensions. Not many think of the root cause as a ‘fat finger’ trade.
So, what is a fat finger trade and why is it in the news lately? Here is everything you need to know about it.
Imagine making typos while texting your friends on WhatsApp. Most of us do it all the time and it’s normal. The same thing done by traders and dealers in the stock markets can result in a massive impact.
If a trader/dealer makes typos while punching in a large buy or sell transaction into the terminal resulting in erroneous trades, it is said that a ‘fat finger’ trade has occurred.
Freak trades refer to unusual and unexpected trades that occur in the stock market due to errors or glitches, also known as “fat finger” trades. A fat finger trade occurs when a trader mistakenly enters an incorrect order, such as buying or selling too many shares or entering the wrong price. This can cause a sudden and drastic change in the market, leading to a significant impact on the stock’s price.
Freak trades are usually caused by a combination of human error and technological glitches, and they can be particularly damaging for traders who are caught on the wrong side of the trade. In recent years, many stock exchanges have implemented safeguards to prevent fat finger trades, such as automatic order checks and limits on the size of trades.
Overall, freak trades and fat finger trades are unpredictable and can have a major impact on the stock market. It is important for traders to be vigilant and to use caution when entering orders to avoid costly mistakes.
One of India’s infamous ‘fat finger’ trades took place back in October 2012. A trader working with stock broking firm Emkay Global Services confused the volume to be price column and punched in a wrong sell order for Nifty stocks of not less than Rs. 650 crores! This order pushed down Nifty by 15% within a matter of a few minutes, resulting in a circuit breaker and temporary shutdown of the exchange.
Unfortunately, Emkay lost close to Rs. 50 crores while hundreds of investors profited by buying Nifty stocks at very low prices.
Since fat finger trades tend to have a larger-scale impact on the markets, a regular investor may lose a lot of money if he/she has entered the wrong side of the trade and if the exchange does not annul the fat finger trade.
Many investors prefer to stay away from the financial markets due to the results of constant intra-day swings caused by any global news. With episodes like fat finger trades, the markets can go through additional jolts and investors may continue to perceive that the risk of investing in markets is something similar to betting.
A fat-finger trade impacted the NSE derivatives segment in early June this year when a broking house placed an incorrect order.
So, what happened exactly?
On Thursday, June 2, 2022, during the afternoon trading session, a trader incorrectly entered an intraday sell order for nearly 12.5 lakh shares on the Nifty call option that was expiring on the same day. While the contract’s price was close to Rs. 2,100 per share, the trader entered the wrong key, resulting in a lower price being quoted for the shares. The share price came down from Rs. 2,100 to only Rs. 0.15 paise within a few minutes.
Although the broking house tried squaring off the position, many investors and traders faced huge losses estimated to be over Rs. 200 crores. The NSE has various alarm systems for trades being executed at unexpectedly lower or higher levels to catch erroneous trades. However, during the execution of the above-mentioned trade, no alarm was set off by the exchange.
Most exchanges in the country and broking houses have set up various preventive measures to avoid fat-finger trades. These mechanisms include alerts for dealers/traders who are trying to place orders that are not as per the usual market parameters. Another mechanism is capping price movements of stocks through cooling-off periods and circuits.
There is presently very little scope to undo the damage caused by fat finger trades. Most fat finger trade instances have resulted in massive intra-day swings on the impacted index, thereby eroding investor wealth by millions. The rising number of algorithmic traders, who primarily rely on technology to identify quick opportunities and deal in volumes within micro-seconds, often multiply the impact of fat fingers. Apart from investor losses, it also erodes the goodwill gathered by involved broking houses.
With too many butter-fingered trades being executed frequently, an ordinary investor continues to place very little faith in the stock markets. It forces us to think about the olden days when erroneous trades may not have had a huge impact as each stock transaction would take hours to be executed. With the advent of electronic exchanges, a single erroneous trade can easily snowball into losses for thousands of investors.
A stock market rally is a general rise in stock prices. A rally may occur in various ways, but it commonly occurs as a comparative, fast and consistent upside price movement.
Apart from asking brokers to put appropriate internal risk mechanisms in place, NSE warned them against executing non-genuine orders that may lead to disturbance in the regular stock price discovery process.
Currently, there is only disciplinary action that the exchanges may take against brokers who execute fat finger trades. The action further depends on the scale of trade, the impact on markets and process flaws on the broker’s part.
Retail investors need to be extra cautious about the markets by using the risk-reward equation in every trade or investment that they make. While stock markets are risky, they can give equal opportunities to earn good returns.
Retail investors must equip themselves with sufficient knowledge of the markets, an understanding of fundamental analysis and the overall risk-return involved in every investment before entering the markets.
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