Move to contain damage from freak trades takes effect today
A change in order type expected to help limit the damage from freak trades is effective from Monday.
The National Stock Exchange (NSE) will no longer allow stoploss orders, which traders used to exit market positions at whatever price was available in the market if their bets went wrong. It will now allow only limit orders, which restrict such execution to a predefined price.
The move is expected to help contain damage if there are freak trades that cause large price swings often because of mistakes in order entry, made worse by the freak trades triggering stop-loss orders.
“Members are requested to note that Stop Loss orders with Market condition (SL-M) for Option contracts shall be discontinued by the Exchange with effect from September 27, 2021. Orders placed with aforesaid condition if any, shall be rejected by the Exchange…stop Loss order with limit condition (SLL) shall continue to remain available for all contracts,” said a September 21 NSE circular.
Consider a trader betting that a stock at ~100 will rise to ~110. The trader can have a market stop-loss, which will sell the share if it falls instead to ~95. Such stoplosses contain instructions to sell at the prevailing market price. This would mean that it would sell at any price from ~95 all the way to zero. Stop-losses as limit orders mean an exit will happen only if the market offers a minimum price (for example, ~85).
Such events are said to have become more frequent after the NSE on August 16 removed restrictions on the price at which a given trade can be executed. Participants have since reported freak trades in the derivatives segment. This included events on August 20 for options traders in the Nifty 50 index contract, and Nifty Bank Index options on September 7.
An exchange spokesperson declined to comment on the freak trade issue beyond circulars already in the public domain.
The trade execution range was restricting market movements, noted Rajesh Baheti, director at the Association of National Exchanges Members of India (ANMI).
It limits the price at which a trade can be executed based on the average of the trade prices during the last one minute. This was in addition to the daily price range that sets the maximum movement allowed during the day. Since the trade execution range was often narrower, options would stop trading because of relatively small movements in price, he said. This was not allowing markets to discover prices freely.
“It was coming in the way,” he said. Large swings in price after its removal could be on account of stop-losses getting triggered at market prices, he said.
While the removal of the trade execution range is in line with global practices, it has introduced the system to some vulnerability to abuse, according to an algorithmic trading system provider and two senior brokerage employees Business Standard spoke to. Highfrequency traders can potentially game the system to their advantage, according to them.
They declined to be identified, citing sensitivity on the issue. The exchange has made available an alert system to prevent freak trades through its software. Some brokers also use other non-exchange solutions. The exchange has asked such brokers to put in place similar features on July 31. There are still some possibilities of freak trades, according to one of the people cited above since some of the onus on risk management is now on brokers.
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