Brokerage Order Errors Can Harm Individual Investors, Too

By Ryan Snefsky

On Thursday, May 6th, 2010, there was a highly unusual market event which resulted in a nearly 1,000 point loss to the Dow Jones Industrial Average in nearly 15 minutes. The actual cause of this event is still under investigation, though speculation has arisen as to whether or not this event was the result of one or more erroneous trades by an institutional investor.

Whether or not the final investigation does discover an error on the part of a trader or computer program, all the public discussion about erroneous trades should create awareness for investors to be on the lookout for errors when entering brokerage orders for themselves, particularly with online brokers.

The existence of major errors among professional money managers is nothing new. In 2005, a trader in Taiwan mistakenly bought 8 billion Taiwan Dollars worth of a particular stock instead of 80 million. This mistake caused many stocks on the Taiwan stock market to rise to levels that were not particularly warranted. Events such as this, however, should be a wake up call to average investors. If institutional investors can make typos or other mistakes, so can the average investor.

While errors in brokerage orders made by average investors may not necessarily influence markets the way an erroneous trade made by an institutional investor might, the effects can be just as devastating personally. A decimal point or an extra zero in the wrong place can cause serious problems. Or, an investor might accidentally enter a market order instead of a limit order and have the trade executed at a price that is unsatisfactory to the investor.

It is also not unheard of for in investor to enter the letters of a particular stock symbol in the incorrect order, such as "XZY" instead of "XYZ." Sometimes the incorrect symbol may actually be a legitimate stock symbol for a different company and stock is still purchased. The issue with all of these errors is that the investor may not only incur additional commissions to unwind the incorrect trades, but the reverse trade may not have sufficient liquidity to get out of the trade at a similar price as the entry.

One of the worst case examples of this occurs with errors in options trades. Many stock options, particularly options that do not trade heavily, have what is known as a "wide spread." The spread is the difference between the bid price and the ask price. In the case of far "out of the money options," it is not unusual to see a bid price of $0.00 and an ask price which is higher. If an investor or trader bought the incorrect amount of an option at the ask price, but the option has a $0.00 bid price, that investor may never be able to unwind the erroneous position and may be statistically likely to lose their entire investment.

In summary, always make sure to double check brokerage orders before you submit them. The cost of complacency in error checking can be quite high if the error is significant enough.