Erroneous Trade

What is an Erroneous Trade?

An erroneous trade is a stock transaction that deviates so much from the current market price that it is considered an error. Erroneous trades are caused by a variety of factors including computer malfunctions or human error. These trades are often reversed, or broken, because they do not reflect the true price of the security and they can influence or cause erroneous trades on other stocks or exchanges.

Understanding the Erroneous Trade

In 2009, the Securities and Exchange Commission (SEC) approved new exchange rules that would stop erroneous trades from being executed. The SEC rules allow an exchange to break a trade if the price differs from the consolidated last sale price by more than a specified percentage amount.

For example, in regular market hours, 10% for stocks priced under $25; 5% for stocks priced between $25 and $50; and 3% for stocks priced over $50. Furthermore, the review process for the erroneous trade must begin within 30 minutes of the trade.

To start the review process the time of the transaction, security, number of shares, price of the transaction, side (buy, sell or both), and a statement of why the trade is considered erroneous must be submitted to the exchange.

The percentage guidelines above are for regular trading hours. Since there is less liquidity in the pre-market and after hours, the guidelines are doubled. For example, on a stock priced under $25, the price would need to deviate by 20% in order to be considered erroneous.

Exchange traded funds (ETFs) and notes (ETNs) have the same guidelines.

Leveraged ETFs have the same guidelines, but during regular hours the guidelines are multiplied by the leverage. For example, an ETN that trades over $50, and is a three-times (3x) leveraged fund, would need to see a trade deviate 9% or more to be considered erroneous.

Consequences of Erroneous Trades

Today’s markets are highly automated and interconnected, with trades occurring rapidly. As a result, an erroneous trade on one market can quickly trigger a wave of further erroneous trades across other interconnected markets.

This can lead to far-reaching and serious consequences for the market. For example, if a stock last trades at $25, but a computer glitch, human error, or some other factor causes a firm to conduct a series of erroneous trades of that stock at $75, other exchanges’ automated systems may follow suit, spreading that erroneous trading price across other markets and affecting numerous markets and investors.

Real-World Examples of Erroneous Trades

In 2010, an erroneous trade was blamed for the nearly 1,000-point flash crash in the Dow Jones Industrial Average. The mistake was rumored to involve E-mini contracts which are stock market index futures contracts that trade in Chicago.

In 2011, two Wall Street Exchanges, Direct Edge and Nasdaq OMX Group, announced the cancellation of dozens of erroneous trades that were executed between 4:57 p.m. and 5:05 p.m. EST on Monday, May 2. The trades involved shares of several companies in the health sector, which jumped precipitously during that day’s after-hours trading session. For example, shares of Becton Dickinson & Co. (BDX) rose from their closing price that day of $86.85 to as high as $112.91.

On January 24, 2023, a manual error on the New York Stock Exchange (NYSE) resulted in a trading halt shortly after the market opened, leading to the cancellation of 4,341 trades in 251 symbols. According to the NYSE, the erroneous transactions were caused by a technical glitch that opened trading in some of the S&P 500’s largest companies, such as McDonald's Corporation (MCD), AT&T Inc. (T), and Exxon Mobil Corporation (XOM), without the usual opening action that assists floor traders in setting opening prices in stocks.

The error led to supply-demand imbalances at the commencement of trade, sending prices of impacted stocks sharply lower from their previous day’s close. For example, shares in retail giant Walmart Inc. (WMT) slumped 12% during the technical glitch, while New York-based investment bank Morgan Stanley (MS) plunged nearly 13% before recovering. The NYSE confirmed its systems and stock prices had returned to normal by 9:50 a.m. EST on the day the erroneous trades occurred.

Bottom Line

Erroneous trades refer to stock transactions that significantly deviate from the current market price, usually caused by system glitches or human error. Exchanges often cancel or reverse erroneous trades to minimize their impact on investors, other securities, and the broader market. The advent of algorithmic trading has resulted in erroneous trades triggering significant market volatility across interconnected markets, prompting regulators to introduce measures that help prevent these types of transactions from occurring.