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What is Freak Trade in the Stock Market?

What is a freak trade? How is it happening? Who are behind these trades? Is this a manipulation or a loophole in the system? Why there is no Upper circuit in premium prices? How can we protect our capital from freak trades?

There have been multiple incidents of freak trades happening in the system and the losers are always retailers like us. After hearing out from top traders across India I understood the Freak trade is a phenomenon where the option premiums trading at a price say Rs 100 spikes to 10X 15X i.e. to 1000-1500 rupees within a fraction of a second and triggering all the Stop Loss Market orders at the at-most price. These premium prices shoot so fast that it is impossible for humans to see and adjust their positions. 

This happened twice in the last two weeks in both Nifty and Bank Nifty and I barely escaped from the bank nifty freak trade because of late entry. Freak trades can easily make retail traders like us go bankrupt if we don’t play smart.

From the above image, you can see that the 16450CE premium which was trading around 80 rupees went to 800 rupees within a second with ultra-heavy volumes. Also, the bank nifty 37100PE premiums trading between 200 to 300 spiked to Rs 1921 lightning fast.

Because of the trades happening like a lightning effect and within a second, it was not even recorded and reflected on charts. Many traders lost a significant amount when this happened, and it triggered all of their Stop Loss Market Orders.

Let us understand how this happened. Imagine Bank Nifty 37100PE premium is at 300 rupees. Normally, the range of stop losses kept by people who sell 37100 strike will range from 30 to 75 percent of the premium value collected. This means the stop loss amount could be from 350 to 600 ranges. When the premium price increases, the SLM(stop loss market) orders will get executed at the market prices. Say for the premium of 300 I’ve kept a stop loss market order at 375, so once the premium price rises, it will trigger the stop loss at 375. Let’s assume that the next available market price is 380, so SLM will get triggered there for a few quantities at that price. Assume after 380 the next available trade price is 400 for some quantity in the system, then a few quantities will get triggered there and it will continue based on the liquidity at each price till the premium hits Upper Circuit.

Now the question is: Why was the Upper Circuit Not hit?

From the 16450CE image, you can observe an upper circuit of rupees 518, but why didn’t the premium freeze? From the 16th of August, NSE removed the execution range limits for Options premium, so the option can get traded at any price as per the revised rules. Is this good for the Market? Sometimes, it’s good to not have a freeze limit, especially when the market makes a sudden violent move. Earlier, what used to happen is that when the market makes violent moves (usually on a fall), the premiums will freeze at the Circuit breakers and trades freeze for a specific duration and you won’t be able to trade or square off your positions. And once the market reopens the Option Premium will be drastically different from its value when it froze, owing to fresh buy and sell orders created in the system during the period and the fact that opening price gets calculated with respect to the supply and demand criteria. The sudden premium difference while market reopening causes loss to many market participants, that too in hefty amounts. To avoid such a scenario, NSE removed the execution range limit.

Why Was this not recorded on charts? 

No matter which broker or terminal, the chart records the data second by second. There are 1000 milliseconds in a second and what happens between the 1st millisecond to 999th millisecond is not recorded or captured by the chart. Many things can happen in between unrecorded milliseconds. There are High-Frequency Trading (HFT) firms that can place an order in 5 milliseconds, and because of this reason, nothing got recorded on the charts as well. So between these milliseconds, all these stop losses got triggered at unimaginable premium prices and the premium price returned to normal.

Who is behind these freak trades?

Obviously, you or me sitting in front of our PC watching charts can’t do this. Understand the fact that institutions and HFTs create and execute over 90% of the trading volume in India.

The High-Frequency Trading firms Algorithms are monitoring the premium prices and once they observe the 37100PE premium is higher than the 37200PE premium price, which is absolutely not possible, they will start shooting sell orders for 37100PE and make easy money out of this absurd situation. Placing large quantity orders within a second or in milliseconds is impossible for humans, as we need at least one sec to push orders. Technically retail order push takes around 200 milliseconds to get executed. HFT can push 20 orders per second compared to 3-4 orders as best possible by the retail community.

How to avoid freak trades? How can retailers protect their capital?

Now carefully understand the type of stop-loss orders and how they work. 

Imagine you have sold 37100PE at a premium of 789.50 By keeping an SL-M order, i.e. stop loss market order at a trigger price of 800, you are giving them authority to execute at any market price which is above 800 and because of no upper circuit limit it can go up to 2000 or 3000 as well.

So better avoid keeping an SL-M order and instead use a SL stop-loss limit order with a difference of 5 rupees between limit and trigger price or any reasonable integer value (without decimals) convenient as per your risk appetite. Be in front of the system always if you have kept a stop loss limit order, to make sure that the market price has not skipped your stop-loss limit price. On Limit orders, the order gets executed only when the market price is exactly equal to your limit order price.

This is the only way to protect your capital from freak trades. Be smart and keep your capital safe. happy trading:).

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