Freak Trade: What It Is and How to Avoid It

Have you ever heard about a “freak trade”? You may have come across this term in the financial markets, but you’re not quite sure what it means. Don’t worry – you’re not alone! 

A “freak trade” is a type of trade that occurs when unusual market conditions lead to abnormal volatility and unfavorable pricing. Freak trades can lead to large losses, so it’s important to understand how they happen and how to avoid them. 

So, what causes a freak trade? In most cases, it’s due to unusual market conditions (Human Error, Algo Trigger, or News). These conditions can include sudden changes in the stock price, large orders placed by investors, or even a “flash crash”, which is when the market suddenly drops significantly. These events can cause a sudden spike in volatility, which can lead to an unfavorable price. 

Another cause of freak trades can be a lack of market liquidity, which is when there aren’t enough buyers and sellers in the market to absorb large orders. This can lead to large losses for traders, as the market will be unable to match their orders in time. Rs.10 Option can become Rs.1000 in just a matter of seconds. Traders have lost crores of rupees and blown their entire capital.

Fortunately, there are steps you can take to avoid freak trades. The first step is to set limits on volatility. This means setting the maximum amount of volatility that you’re willing to accept on a given day. This will help you limit your risk and avoid any sudden price swings. Or better avoid trading in a hugely volatile market.

The second step is to monitor market conditions. You should keep an eye on the news and any changes in the markets. This will help you identify any potential events that could lead to a freak trade.

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The third step is to use protective strategies. These can include stop losses, which will automatically close your position if the price reaches a certain level. You can also use options, which are contracts that give you the right to buy or sell a stock at a certain price. These strategies can help you protect your investments and limit your losses. 

Finally, the solution for freak trade is to utilize risk management techniques. This means understanding the risks associated with trading and taking steps to limit them. You should also stay up to date on market changes, as this can help you identify potential risks and take steps to protect yourself. 

How does Freak Trade happen?

A fat finger trade happens when someone makes a mistake while placing an order. For example, if someone was trying to place an order for 1000 quantities of Banknifty but accidentally places 1000 lots of Banknifty, they would have made a fat finger trade. This is because they accidentally bought more than they meant to. Fat finger trades can lead to big losses due to human errors. Algo trades can also be the reason for sudden price spikes for specific strike prices.

When does Freak Trade Happen?

Freak trades usually happen when the markets are volatile or when there is a big news announcement. For example, when the elections are near, the markets tend to be very volatile and investors may place orders without considering the market conditions. This can lead to sudden price spikes and freak trades. If there is no such event, freak trade happens at the market opening time. So it’s good to avoid trading for the first 5 mins. Let the market settle first and then place the order.

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How To Avoid Freak Trade?

Traders must be careful when placing orders in the stock market, especially in the derivatives segment like options selling and buying. It’s important to use a limit order (SL) instead of a market order (SL-M) so that you can set a price you’re willing to pay for a stock. This way, if the stock’s price jumps suddenly and keeps rising, your order will still be filled at the price you set. You can also set a buffer of 1-2% between your trigger price and the price of the stock so that your order won’t be filled if the stock’s price rises too quickly. By using limit orders and setting a buffer, you can help protect yourself from losses due to freak trades. The Freak trade returns to normal in a matter of a couple of minutes. If you set an SL-M order the order can be executed at any price the market might be quoting at that time.

Another solution to avoid blowing your entire account that open multiple Demat accounts and park your money evenly in multiple accounts and trade from different accounts. This way if something like this happens you just lose 1 demat account balance and the rest of the money in different demat accounts will be safe. You can open demat account with all brokers. There is no limit to how many demat accounts you can open. So take advantage of opening multiple demat accounts as most of the Brokers do not charge account opening and account maintenance (AMC) charges.

Conclusion

In conclusion, freak trades can be a costly mistake for traders. However, understanding how they happen and taking steps to protect yourself can help you avoid them. Setting limits on volatility, monitoring market conditions, and utilizing risk management strategies can help you protect yourself from losses due to freak trades. Additionally, opening multiple demat accounts can help ensure that you are not overexposed to any single trade. By taking these steps, you will be better prepared to identify and avoid freak trades.

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