DEFINITION of 'Cancellation'
A cancellation is a notice made by a broker, to his client, informing him an erroneous trade was made and is being rectified. Despite the fact technology is an ever-present and ever-evolving part of daily life, trading mistakes are made, either by human or electronic error, and brokers must correct the mistake immediately, notifying the client of all errors and actions taken to resolve the mistake. Naturally, all transactions and steps taken are recorded to lay out the cancellation and ensure the broker is not mishandling the account.
BREAKING DOWN 'Cancellation'
While technology plays a vital role in the trading world and has arguably made trading more efficient and speedier, it can also play a role in erroneous trades being made and thus generate the need for a cancellation.
Examples of Cancellations
One example of a cancellation involves overbuying. Assume a broker purchased 4,000 shares of company ABC for a client, but the order was supposed to be for 3,000 shares. The broker made a purchase in excess of the amount specified by his client, accidentally substituting a four for a three. In this instance, the broker is required to sell the additional 1,000 shares purchased at his own expense. The broker must then make a cancellation notification to his client, explaining the error and the steps he has taken to correct the mistake.
For another example, imagine a client asks his broker to purchase 500 shares of company XY, but the trading floor puts in an order for 500 shares of company Y instead. The client receives a cancellation notification indicating this error. The client's broker must then correct the error by quickly putting in the correct order. If the price of the shares for company XY increase before the broker puts in the correct order, it is his responsibility to take on the additional cost per share, offering the client the original cost of 500 shares in the company at the time the order was requested.
Despite all modern conveniences and tools, erroneous trades occur on a fairly regular basis, whether due to a technological malfunction or due to human error. The Securities and Exchange Commission (SEC) approved new rules on exchanges in 2009 to stop erroneous trades from being executed. These new rules permit an exchange to break trades when the price differs by a specified percentage from the last consolidated sale price. As an example, during regular market hours, the percentages are 10% for stocks under $25; 5% for stocks priced between $25 and $50; and 3% for stocks valued at over $50. Also stipulated in the SEC's new rules: erroneous trade reviews must start within 30 minutes of the trade and be resolved within 30 minutes of the review process.