Social media is abuzz with incidents of ‘freak trades’ in the stock market. Incidents of people losing lakhs of rupees within a matter of seconds: that too without any mistakes of their own. What’s going on?
What are freak trades?
Here’s the thumb rule to make money in the stock market: Buy Low, Sell High or Sell High, Buy Low. Something that we all know.
Now, imagine that you are looking to buy a stock market instrument at Rs. 200. You check the price and it is trading at Rs. 200. You jump with joy and place the order to buy 300 units at ‘Market Price’.
But something weird happened. By the time the trade got executed, the Market Price jumped to Rs. 400.
Can’t believe it!
You refresh the screen. Market Price is back to Rs. 200. It was just your order that got executed at Rs. 400 and now there is no way that you will be able to sell higher than Rs. 400, suffering an instant loss of Rs. 60,000.
Scenarios like this are known as “freak trade”. Something that will definitely freak you out!
But why is this happening now? And that too very frequently.
Trade Execution Range
Well, on 16 August 2021, NSE removed something called ‘Trade Execution Range’. Since then, all hell broke loose.
Humans are prone to making errors. Imagine placing a buy order at Rs. 1,000 instead of Rs. 100 for 900 units of an instrument by mistake.
Damn you fingers! They just lost you Rs. 8,10,000! This move could also lead to volatility in the market.
To prevent ‘fat finger’ situations like these from happening, NSE had a system called ‘Trade Execution Range’ (TER) in place. Based on a certain formula, NSE would regularly define a range of price within which a trade can be executed. So if the current price is at Rs.15,000, you can only enter into a contract between the price range of Rs.14,250 and Rs.15,750. This eliminated the chance of anyone trading at outrageous prices.
However, this system was not perfect. Many times the TER would be way different from the price of the instrument. This would disable participants from trading at all. That’s when NSE would have to manually change the TER.
And so, to remove this inefficiency, NSE scrapped TER altogether. This move was in line with what other stock exchanges around the world were doing. They let demand and supply decide the range of trade. But now, the traders were on their own. The chances of freak trades because of human error went high.
So does that mean you can do nothing about it?
Well, you can. Nithin Kamath at Zerodha has suggested a solution.
Solution
When you go to purchase a security, don’t purchase with the Market Price feature. (Bless Zerodha, it removed this feature on stock options some years back).
Instead you can place limit orders. Basically, if you want to buy something at Rs.200 you place a limit order at Rs. 200. Even if the price rises, your buy order won’t execute beyond Rs. 200.
But isn’t it very convenient, having so many episodes of freak trade in such a short span of time? Someone’s loss could be someone else’s gain also, right? Don’t you smell a dead rat?
Well, SEBI is investigating the incidents at their end.
All we can do is minimize the risks at our end.
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