How To Identify 'Fat-Finger' Trades

Trading is inherently fraught with risk. Now, imagine the risk being compounded by man-made errors that could lead to huge losses in double-time.

Fat-Finger Trading

A "fat-finger trade" is a trade marred by human error arising out of pressing the wrong key when inputting data into a computer. The error’s magnitude becomes egregious in the current era of abounding algorithmic trades, which use advanced and complex mathematical models and formulas to make high-speed decisions and transactions.

Fat-finger trades may also set in motion further losses through initiation of algorithmic trades in automatic response. The chain of events could lead to a market crash as was seen in the flash crash of 2010.

A Few Instances Of Fat-Finger Trades

• Late last year, Deutsche Bank inadvertently transferred $6 billion to a single hedge fund customer account.
• The London Stock Exchange had its tryst with fat-finger trading in September 2015 when the key index of the exchange, the FTSE 100 Index, fell dramatically. The bizarre drop was traced back to a trade executed at 12.44 p.m. local time that fateful day, which was supposedly a fat-finger trade on a basket trade order. The end result was suspension of trading in nine companies, including HSBC Holdings plc (ADR) HSBC and BP plc (ADR) BP. The trader reportedly lost 500,000 pounds on the transaction.
• On October 2014, a fat-finger trade by a dealer in the Tokyo Stock Exchange led to the placement of a $622 million order to buy blue chips such as Toyota Motor Corp (ADR) TM. Incidentally, the trader had entered both price and volume data in the same column.
• Japan’s Mizuho Securities accidentally placed an order for selling 610,000 shares of J-Com for 1 yen each, while the intent was to sell 1 share for 610,000 yen. The transposition could not be cancelled due to a technical glitch at the stock exchange.
• In 2001, an input error led to an 8.1 billion-pound order being nearly placed to buy shares of Autonomy, with the trade value about 4 times the market capitalization of the company. The error was caught on time and the trade was cancelled immediately.

Exchanges have specific deadline for requesting a review and cancellation. The New York Stock Exchange’s time frame is within 30 minutes of the execution of the erroneous trade.

Identifying Possible Fat-Finger Trades

Now to the billion-dollar question of how an investor can identify fat-finger trades in a bid to cut or minimize their losses:

• Be attentive to any abnormal and unusual big bounce, or steep pullback without any fundamental or extraneous reason. In October this year, the British pound crashed by 6 percent to $1.1378 , with experts believing an accidental fat-finger transaction being among the many reasons for having caused the slide. Usually, the move would be more pronounced when accompanied by light volumes, as there may not be much activity to offset the move triggered by a single erroneous trade.
• Deutsche Bank reportedly operates a policy called 'four eyes,' which requires every trade to be scrutinized by a second person before being processed. It is an irony that that even after such safeguards in place, the bank fell victim to the malaise.
• Firms can also have controls such as pre-trade order size limits that prevent block trades above a certain limit, straight-through processing and trade order management systems and rigorous trade confirmation back-office processes. Automated systems that can spot trades not confirming to the usual size by a significant margin can be had at the end of the broker dealer and the exchange.

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