If you are an active trader in the Indian stock market, you might have heard of the term "freak trade" or have seen some examples on social media. A freak trade usually happens when a big company or trader makes a big mistake. This mistake is so vast and wrong that it can mess up the value of a whole bunch of stocks (or even a group of stocks called an index). For instance, in India's stock market, there exists the Nifty index.
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Reasons for Freak Trades
A freak trade can happen due to various reasons, such as:
- Human error: A trader may accidentally enter the wrong price or quantity while placing an order or hit the wrong button on the trading terminal.
- Technical glitch: A software bug, a network failure, or a system outage may cause an order to be executed at an incorrect price or time.
- Algorithmic trading: A high-frequency trading (HFT) algorithm may malfunction or misinterpret market signals and place orders that are out of sync with the market conditions.
- Market manipulation: A malicious actor may deliberately place orders intended to create artificial price movements or trigger stop-loss orders of other traders.
Examples of Freak Trades
Some examples of freak trades that have occurred in the Indian market are:
- On September 14, 2021, futures contracts of TCS, Bharti Airtel, and HDFC twins – HDFC & HDFC Bank - recorded an exponential jump of around 10 percent each for a few nanoseconds in early trading hours. The jump was because of a technical glitch at the National Stock Exchange (NSE).
- On September 17, 2021, futures contract prices of HDFC reached a level of Rs 3,135 even as the spot price was hovering around Rs 2,850 apiece. The spike was due to a freak trade caused by low liquidity and high impact cost.
How do Freak Trades Affect the Market?
Freak trades have a significant effect on the market. These are:
- Price distortion: This kind of trade can create temporary price anomalies that deviate from the fair value of the underlying asset. It affects the price discovery process and the valuation of other related instruments.
- Market volatility: Freak trades can increase the uncertainty in the market, as traders may react to sudden price movements and adjust their positions accordingly. This can lead to more fluctuations and swings in the market.
- Investor confidence: These trades can erode the confidence and trust of investors in the market, as they may perceive the market as rigged or unreliable. Due to this, there is a reduction in the market's participation and liquidity, affecting its growth and stability.
How to Protect Yourself from Freak Trades?
As a trader, you cannot completely eliminate the risk of freak trades, but you can take some measures to mitigate your losses.
- Use limit orders: A limit order is an order that specifies the maximum or minimum price at which you wish to buy or sell a security. By using limit orders, you can avoid getting executed at unfavorable prices far from the current market price. Limit orders also help you control your risk and manage your money effectively.
- Avoid market orders: A market order is an order that executes at the best available price in the market at that moment. While market orders help you enter or exit a trade quickly, they expose you to freak trades risk. Market orders can get filled at prices significantly different from what you expected, especially in illiquid or volatile markets.
- Use stop-loss orders: A stop-loss order is an order that automatically closes your position when the price reaches a predetermined level. Stop-loss orders can limit losses and protect profits in case of adverse price movements. However, you should also be aware that freak trades can trigger stop-loss orders and cause you to exit your position prematurely.
- Monitor your positions: You should always monitor your positions and the market conditions and be ready to act accordingly. You must also regularly check your trade confirmations and statements and report any discrepancies or errors to your broker or exchange as soon as possible.
Freak trades are rare but unpredictable events that can cause huge losses or gains for traders and affect the market dynamics. As a trader, you should be aware of the causes and consequences of freak trades and take steps to protect yourself from them. By using limit orders, avoiding market orders, using stop-loss orders, monitoring your positions, and diversifying your portfolio, you can reduce your exposure and mitigate your losses from freak trades.
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