Understanding Freak Trades in the Stock Market

A freak trade in the Stock Market can cause unexpected price fluctuations and trigger stop-loss orders, leading to significant financial losses. It is crucial to understand such trade types before jumping into trading securities. So, this guide will explain what a freak trade is, how it happens, and ways to protect your investments.

What is a Freak Trade?

A freak trade is an unusual and unexpected trade in the stock market that causes a sudden and significant price movement in a stock or index. These trades often occur due to errors, either human or technical, and can lead to drastic fluctuations in stock prices for a brief period.

Typically, freak trades happen when there is a mismatch in the buy and sell orders, often due to erroneous entries or automated trading glitches. For example, an incorrect entry of a large trade order can lead to a sharp spike or drop in the stock price. Such anomalies can disrupt the market, triggering stop-loss orders and causing panic among investors.

The meaning of freak trade lies in its ability to create temporary market anomalies that can substantially affect investors’ portfolios. These trades are usually corrected quickly as the market returns to its normal trading patterns, but the interim impact can be severe, particularly for those with stop-loss orders set at levels impacted by this trade.

Freak Trade and Trigger in Stop Loss Market Orders

Freak trades can significantly impact stop-loss market orders. A stop-loss order is an automated order to buy or sell a stock once it reaches a certain price, designed to limit an investor’s loss of a position. However, during a freak trade, sudden and abnormal price movements can trigger these orders prematurely.

When a trade occurs, the abrupt price spike or drop can hit the stop-loss levels set by investors. This can lead to the execution of sell orders at much lower prices or buy orders at much higher prices than intended, resulting in unexpected losses or missed opportunities.

Additionally Read: Demat Account Meaning

For example, if an investor has a stop-loss set at Rs. 100, this trade might temporarily drop the stock price to Rs. 95, triggering the stop-loss and executing the sell order, even though the price might quickly recover.

How Do Freak Trades Happen?

1. Human Error: One of the most common causes of freak trades is human error. This can include entering incorrect trade amounts and prices or executing trades unintentionally. For instance, a trader might accidentally enter a sell order for 10,000 shares instead of 1,000, causing a significant impact on the price.

2. Algorithmic Trading Errors: Automated trading systems or algorithms are designed to execute trades based on pre-set criteria. However, these systems can malfunction or misinterpret data, leading to these trades. For example, a trading algorithm might misread a data feed and place large orders at incorrect prices.

3. Technical Glitches: System errors and glitches in trading platforms can also result in these trades. These might include software bugs, connectivity issues, or data feed errors that cause unintended trades or price movements.

4. Market Illiquidity: Even small trades can cause significant price movements in markets with low liquidity. During periods of low trading volume, a single large order can drastically affect the stock price, leading to a freak trade scenario.

What is a Fat Finger Trade?

A fat finger trade is a specific type of freak trade caused by a trader’s typing error when entering a trade order. This mistake can involve inputting an incorrect number of shares or the wrong price. For instance, a trader intending to sell 1,000 shares might accidentally type 10,000, leading to a significant and unintended market impact.

Fat finger trades are typically the result of simple human error but can cause substantial disruptions in the market. The consequences can be severe, triggering widespread selling or buying and temporarily influencing stock prices until the error is recognised and corrected.

While trading systems often have checks to prevent such errors, they still occur and can lead to notable financial losses and market volatility.

How to Protect Your Investments?

1. Use Limit Orders: Instead of market orders, use limit orders to control the price at which your trades are executed. This can help prevent executing trades at unfavorable prices due to a freak trade.

2. Set Appropriate Stop-Loss Levels: Carefully set your stop-loss levels to avoid triggering them due to temporary price anomalies. Consider the stock’s volatility and typical price movements when setting these levels.

3. Monitor Trades Regularly: Regularly monitor your trades and the market to identify any unusual activity promptly. This allows you to act quickly if a freak trade occurs.

4. Diversify Your Portfolio: Diversifying your investments across different asset classes can reduce the impact of this trade on your overall portfolio. This approach helps spread risk and mitigate losses.

5. Stay Informed: Keep abreast of market conditions and news that might impact your stocks. Being informed helps you make better decisions and react appropriately to market anomalies.

6. Utilize Advanced Trading Tools: Many trading platforms offer advanced tools and features to help manage risk. Use these tools to set alerts, automate trades, and monitor market conditions effectively.

Conclusion

A freak trade can cause significant disruptions in the Stock Market, leading to unexpected financial losses for investors.

By using strategies like limit orders, setting appropriate stop-loss levels, and staying informed, you can mitigate the risks associated with these trades. For new investors, opening a free demat account can provide the necessary tools and features to navigate the complexities of the stock market effectively.