What is Freak Trade?

A freak trade is a trade done by mistake when the price briefly reaches an unexpected level before returning to its previous level. This mistake may impact and destroy the value of an entire fund group (or even an index group of funds). Technical problems, human error, or manipulations may lead to the occurrence of freak trade. The freak trade is also known as fat finger trading. Let's learn about it in detail "what is freak trade" by understanding the concept through the example of freak trade, how it occurs, and more.

Examples of Freak Trades

Freak trades can occur due to various reasons in the stock market. Let’s understand the freak trade meaning better with the help of some examples.

• Example 1: One example of freak trade might be a technical glitch within the share marketplace that causes exceedingly abrupt price fluctuations in shares for a short period. This may lead to the price changing by a large amount within seconds.
• Example 2: Another instance of a freak trade can happen when there's low trading activity for a particular stock. In this situation, even a small trade can cause a big shift in the stock's price. For example, a futures contract might show a much higher price than the actual stock, creating a significant gap between the two.
• Example 3: Sometimes human error may also lead to freak trading. This can take place when a person, by accident, enters the incorrect number when placing an order. For example, a person enters 10,000 shares to trade when they want to trade for 1,000 shares. Such errors, commonly known as "fat finger" errors, can lead to sudden price increases within the share market.

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How Do Freak Trades Happen?

The following are some factors listed that lead to the occurrence of freak trade in the stock market. 

• Manual errors: These are mistakes made by investors or traders when they enter stock market orders. It is also commonly known as fat finger trades; these trades witness investors or traders entering the wrong quantity of securities at the wrong price and other order-related factors.
• Placing stop-loss orders as market orders: This trade may also happen when stop-loss orders are placed as market orders by traders and investors without monitoring the market volatility. In such cases, market orders, which are supposed to be placed immediately at the CMP (current market prices), increase the chances of freak trades.
• Technical errors: Freak trade happens when the algorithm used to place orders has some coding issues. Since orders are placed fast and continuously, the outcome is highly volatile, which further leads to inappropriate trade execution.

How to Protect Your Investments From Freak Trade?

The following are some ways listed to protect your investments from freak trade. 

• Use Limit Orders: It is safer to use limit orders when buying stocks or other financial instruments. You may set a price slightly higher than the current market price. This will help you avoid sudden price increases. Limit orders give you more control over your pricing and can lead to unexpected losses from surprise trades. 
• Avoid Market Orders: Market orders involve the buying and selling of shares and other financial instruments at whatever price is available at the time of placing the order. They are quick but can be risky during unusual market conditions. In fast-moving markets, you could end up paying much more than you expected. To protect yourself from freak trades, you may avoid placing market orders.
• Set Stop-Loss Orders: Stop-loss orders sell your investment automatically when the price goes below a certain level. They contribute to limiting losses and gaining potential earnings. Take note that freak trade can unexpectedly trigger these stop-loss orders. Therefore, it is important to wisely choose the stop-loss level for safety and ensure to not sell the initial investment too early. 
• Keep a Close Eye on Your Investments: It is a good practice if you regularly check your positions and stay up to date with market conditions. This way, you can react fast to unusual events. Review your trade confirmations and account statements often. If you see any errors or strange activity, you may report it to your broker or the stock exchange immediately. Being informed about the trading practices and market conditions may help you to address freak trade issues early.

Place Limit Orders in Freak Trades

Limit order acts are a safety net against freak trades in the Indian stock market. When you place a limit order, you can specify the maximum price you are willing to pay for a stock or the minimum price at which you want to sell. For example, if a stock is trading at ₹100, you might place a buy order with a limit of ₹102, indicating that you don’t pay more than that.

During freak trades, market orders without limits are executed at prices way higher or lower than expected and may result in losses. Limit orders act as a safety net by preventing execution outside the specified price range.

Suppose a stock jumps from ₹100 to ₹110. A market order would execute at ₹110 and a limit order of ₹102 would not execute and would protect the investor from overpaying. This way investors can control their trades and reduce risks of market volatility.

Stop-loss Limit Orders in Freak Trades

In the share market, freak trades may have a significant impact, be it for a short time. As mentioned above, investors may use stop loss to protect their investments. Stop loss is a risk management tool for traders in volatile markets. This mechanism allows them to set a lower limit on their holdings. Let’s understand how it helps to protect your investment from freak trade today, to give you a smooth trading process and outputs in the future.

During a freak trade, stock prices may tend to fluctuate and trigger stop losses. For example, an investor buys a call option for ₹1000 and sets a stop loss at ₹900, meaning here the investor experiences a maximum loss of ₹100. If a freak trade takes the call option price to ₹750, the stop loss gets activated and settles the trade.

What is a Fat Finger Trade?

A fat finger trade refers to a mistake in financial trading caused by human error when entering trade details. This happens when a trader accidentally hits the wrong key or enters the wrong information and gets an unintended trade. 

For example, a trader might add an extra zero to a buy or sell order, and it’s much bigger than intended. These mistakes can usually cause huge losses and market disruption. Fat finger trades can cause sudden and dramatic price moves in a security. The fat finger trade is also known as the freak trade. While modern trading systems have safeguards to prevent these errors, they may still happen. Exchanges and regulators may cancel these trades if they spot them quickly, but if left unchecked, the consequences can be severe.

Conclusion 
Freak trades refer to trading errors emerging from technical failures, human mistakes, or manipulation. They can cause potential losses for investors and affect market equilibrium. Even modern trading systems that can carry safeguards are prone to freak trades. Investors can avoid risks resulting from freak trades with protective methods, like the limit order and set stop-loss limits. These freak trade prevention methods can be done through a reliable share market app. Understanding freak trades and implementing preventive measures remains essential for protecting market integrity and investor interests.