What Is Freak Trade in the Stock Market?

While trading in the stock market, one often encounters unexpected price fluctuations. In options trading, in particular, prices can swing sharply either up or down within a very short span of time. In such situations, a trader must understand why this occurred and how it might impact their position. One such phenomenon is the ‘freak trade,’ which we will explore further using simple examples.

What Is Freak Trade? 

Freak trade meaning in the stock market is when a stock or option sells at a price far away from its actual value; people call it a ‘freak trade.’ It mostly happens due to a wrong order entry, thin trading volume, or weird order book setups. Keep in mind, though, not all sudden price spikes are freak trades; prices also swing fast during big news or quick shifts in market action.

Freak Trade Example

Suppose an option is trading at around Rs. 50, but a trade is suddenly executed at Rs. 5. If this occurs due to an unusual order or market conditions, it could be an example of a ‘freak trade.’ However, it is essential to examine the order and trade details to determine the exact cause.

What Causes Freak Trades in the Indian Stock Market? 

There are several key reasons for “freak trades.” Particularly in the F&O (Futures and Options) segment, low liquidity and orders placed at incorrect prices can lead to trades being executed at prices significantly different from the prevailing market rate.

1. Low Liquidity

When there are few buyers and sellers for a specific option, executing large orders at the standard market price can be difficult. This can result in trades being executed at unusual or outlier prices.

2. Incorrect Order Entry

If a trader accidentally enters an incorrect price or quantity, the order may execute at a price different from what was intended. This is often referred to as a “fat-finger error.”

3. Algorithmic or Technical Errors

Malfunctions in trading algorithms or technical glitches can cause erroneous orders to reach the market. However, not every unusual price movement is caused by a technical glitch.

4. Wide Bid-Ask Spread

When there is a significant gap between the buy and sell prices of a contract, a market order may execute at a price different from expectations. This risk is often higher in options with low liquidity.

5. Unrealistic Price Orders

If a trader places an order at a price far removed from the current market rate, it can create an anomalous situation in the order book. If such an order gets matched, it can lead to price irregularities. The NSE employs measures such as pre-trade risk checks and “Limit Price Protection” to control and mitigate the impact of such orders.

What Happens to Traders During a Freak Trade? 

During a “freak trade,” traders can face issues ranging from sudden financial losses to difficulties with order execution. This can impact their positions and trading decisions.

• Unexpected Financial Loss: If an order is executed at a price significantly different from expected, the trader may incur a loss. For instance, a sell order executed at a lower-than-expected price would result in lower proceeds.
• Stop-Loss Triggered at an Unexpected Time: Abnormal price movements can trigger a stop-loss order. However, the trigger price and the actual execution price may differ.
• Slippage During Order Execution: Due to low liquidity or rapidly changing market conditions, an order might be executed at an available price other than the expected one; this is known as “slippage.”
• Margin Shortfall in Open Positions: If the value of a position changes rapidly due to an abnormal price, margin requirements may increase in certain cases, depending on the position and applicable margin rules.
• Confusion in Charts and Trade Records: A sudden price spike on a chart can confuse a trader. Therefore, it is crucial to verify the actual price and quantity at which the trade was executed.
• Difficulty in Exiting a Position: In low-liquidity situations, a trader may struggle to find a buyer or seller at a favorable price to close their position, increasing the risk of greater losses.

How Can Traders Reduce Freak Trade Risk? 

While you can’t completely wipe out the risk of a freak trade, you can easily lower your chances of losing money by checking a few quick things before you hit that trade button.

• Check Liquidity Before Trading: Before you jump into any option trade, always look at the gap between the buy and sell price along with the market volume. If that price gap feels too big or hard to enter and exit, it’s safer to step back and hold off.
• Use Limit Orders: Setting a limit order lets you lock in the highest price you want to pay or the lowest price you’re willing to sell for. It stops your order from filling at a bad price, even if it means the trade might not go through.
• Verify Order Details: Double-check every single detail, whether stock or index, option expiry, strike price, order quantity, and buy/sell side. Don’t rush into a trade and make a silly typing mistake.
• Avoid Trading Solely Based on Price Spikes: Don’t jump straight into a trade just because you see a sudden, steep candle on the chart. First, figure out if actual news caused the move or if something weird is happening in the market.
• Review Unusual Executions: If your order fills at an odd price, immediately check your trade log, order book, and contract note. Reach out to your broker if things look wrong, and save all your order details in case you need to escalate it.

How Does NSE’s Limit Price Protection Work? 

The NSE implemented Limit Price Protection (LPP) in the Futures and Options (F&O) segment effective October 31, 2022. Its objective is to prevent certain limit orders placed at erroneous or abnormal prices from reaching the exchange. LPP serves as an additional check alongside the existing Operating Price Range (OPR).

A Simple LPP Calculation

According to the parameters published by the NSE, for index and stock options with a reference price of Rs. 50 or less, the LPP range extends at least Rs. 20 above and below that price.

Suppose an option has a reference price of Rs. 40 and a range of ±Rs. 20 applies to it.

Description	Calculation	Price
Reference price	–	Rs. 40
Lower limit	Rs. 40 – Rs. 20	Rs. 20
Upper limit	Rs. 40 + Rs. 20	Rs. 60

In this example, a limit order priced outside the ₹20 to ₹60 range could be rejected during the LPP check. However, OPR and other applicable rules also influence actual order acceptance.

Does LPP Eliminate Freak Trades?

Nope, it doesn’t. LPP might block a few weird limit orders here and there, but it won’t totally save you from every freak trade or market loss. So, you still have to double-check the price, market depth, and overall liquidity on your own before hitting buy or sell.

Read Also: What is Carbon Credit Trading Scheme? Types & Example

Freak Trade vs Normal Market Volatility 

Base	Freak Trade	Normal Market Volatility
Price change	The trade may be executed at an unusual price.	Prices change due to market demand, supply, or news.
Main reason	Incorrect order, low liquidity, or unusual order book conditions.	Company results, market news, or investor buying and selling.
Example	Suppose the normal price of an option is ₹20, but a trade is suddenly executed at ₹2.	If a company’s share price rises from ₹100 to ₹105 following good results.
Impact on traders	Trading at an unwanted price can result in a loss.	Failure to gauge the correct direction can lead to losses even in a standard trade.
What should be checked?	Actual execution price, order book, and trade records.	Market news and reasons for changes in volume and price.

Conclusion

The real issue with a ‘freak trade’ arises when a trader discovers that their order has been executed at a price vastly different from what was expected. In such a situation, rather than panicking, it is essential to examine the trade details. While not every market fluctuation can be prevented, maintaining accurate information about the order is within the trader’s control.

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