At some point of time, most of us have accidentally placed online orders for more than what we intended to buy, for instance typing ‘11’ instead of ‘1’ or accidentally sent a mail/message to the unintended recipient. Such human error is known as ‘fat finger trade’. Let us understand the nuances of fat finger trading and how it impacts investors.
Fat finger trading
Since the trader / broking house staff has made a wrong purchase / sale just because the finger clicked more than one button, it is called ‘fat finger’. Generally, in the securities market, the price of the securities is determined by demand and supply. When such an error happens, it affects the price-quality of securities determined by the markets and the regular price discovery process. The consequences of the fat finger error can be devastative if the mistake is committed by a person in big broking houses, while there may be no or minimal impact if done by a retail investor.
Are there any remedies available?
With the advent of technology and the use of algorithms for trading, the impact of fat finger trading can snowball within a fraction of seconds. Now, one may think there might be institutional mechanisms, guidelines and/or rules relating to it. Globally, stock market regulators and stock exchanges follow the ‘no cancellation/trade modification’ approach. They believe that the broking firms should have appropriate checks and balances related to erroneous trading.
One of the solutions related to fat finger trade is that the exchanges are free to decide regarding the cancellation/annulment of the trade. The other solution is that the broking firms would have to settle amongst themselves mutually, and the most common solution is that most of the orders are insured against such unforeseen events. Hence, insurance can be claimed when an erroneous order is placed. Other than these there are no legal-bound regulations put forward by SEBI or the stock exchanges.
The SEBI had initiated a discussion paper focussing on issues related to erroneous trade and to frame guidelines related to fat finger trading since its prime interest is to protect the investors but it is yet to materialise. But why? The reason for the policymakers’ aversion to put forward such regulations is as follows.
First, if such a mechanism exists, there will be a moral hazard since the broking firms will tend to make more such mistakes. There will be an increased number of such instances, thereby decreasing the relevance of the risk quotient of trading systems. Therefore, the broking firms will not have efficient risk management mechanisms. Second, if such mechanisms are put in place, some ill-intentioned market players may resort to market manipulation.
Another significant aspect related to annulment and cancellation of such trades is the operational cost associated. Hence, the policymakers are identifying the grey areas that need attention and are trying to frame a holistic and comprehensive framework that can address issues related to fat finger trading.
Way forward and impact on investors
Given the lack of institutional mechanisms, the broking houses/ traders should have strong internal control and monitoring mechanisms that can minimise and ultimately eliminate erroneous trade. Brokerages can have a two-layer authentication scheme so that if one agent commits an error, the other can prevent it. A trigger for such mistakes is the stress associated with the job and hence, the broking firms can advise their employees to take short breaks since all day long they are doing repetitive data entry which might numb their cognitive ability. And finally, brokerages can come together and invest in research and development in developing AI and ML technologies that can detect and prevent such mistakes.
Even though these fat finger mistakes will create chaos in the market within a fraction of seconds, the market and the market players are resilient in the long run. Hence, the impact on the investors owing to fat finger traders is minimal.
(The writer is a professor of finance & accounting at IIM Tiruchirappalli. With inputs from A Paul Williams, research staff at IIM Tiruchirappalli.)