What is a 'fat-finger trade' or freak trade?

It was one such wild swing at the National Stock Exchange -- triggered by a fat finger-- which had catapulted Chitra Ramakrishna to the helm of India's biggest bourse in April, 2013.

On October 5, 2012, the so-called “fat finger trade” had triggered a massive flash crash wiping off about Rs 10trillion of investors' wealth at NSE.

NSE CEO Ravi Narain had to pay the price and the baton was passed to Ramakrishna, who later got consumed by another bizarre scandal.

Moving on, last week the derivative segment on the National Stock Exchange witnessed a freak trade in the weekly Nifty 50 options contract, reportedly resulting in a loss of nearly Rs 200 crore for the trader.

This is not just a one-off instance. There have been such freak trades -- caused by human error. They are called the fat-finger trade. 

On Thursday, Bloomberg Law reported that Citigroup Inc could suffer losses of over $50 million after a London-based employee's fat-finger trade caused a flash crash in European stocks last month. Citigroup is still in the process of calculating the exact loss.

In 2018, Deutsche Bank mistakenly transferred 28 billion euros to one of its outside accounts, more than the bank's market value.

Back in 2006, a fat-finger error by a trader at Mizuho Securities in Japan caused the firm to short sell a stock in an error that cost the firm 40 billion yen to unwind.

So, what exactly is a fat-finger trade?

To start with, a fat-finger trade is a human error while punching an order. This can include entering a wrong value in terms of price or quantity or selection of the wrong execution action such as buy or sell.

As soon as the freak trade gets executed, the price hits an abnormal level for a fraction of a second and then returns to the level where it should actually be. For instance the recent June 2 freak trade

The trader executed a large sell order in Nifty 14,500 call option at Rs 0.15. In contrast, the then quoted price of over Rs 2,100 as the spot stood at 16,600 level. 

Here, the chances are that the trader might have selected the wrong contract. He or she may have wanted to place the sell order in either 14,500 put or the 16,500 call instead. 

The contract eventually closed at Rs 2,139, resulting into a loss of nearly Rs 200 crore on the basis of the traded volume, according to various reports.

Freak trades not only result in  a loss to the trader who punched the order, but also others who may have placed a Stop Loss order to their open positions, as their Stop Losses may have got triggered due to the abnormal price movement.

But the freak trades can be avoided if caught in time.

The exchanges and brokerages have made constant efforts to avoid such fat-finger trades by placing some preventive measures. 

The exchanges and most brokerage houses have set filters to alert the traders while placing orders outside the typical market parameters. Similarly, the price movements are capped by placing of circuit filters and cooling off period.