The most compelling reason for a trader to do so would be to segregate errors in execution from the performance of any trading system or program he or she is utilizing. A large error — in either direction — can create a false picture of system performance and cause you either to maintain a losing strategy or attempt to fix something that is not broken. The second reason would be to keep track of errors. A growing error account is a red flag telling any trader to pay more attention to the job at hand, or that additional checks must be built into his execution. Self-discipline is an important part of the makeup of any successful trader and concentration on order execution and position tracking is an obvious test of this trait. A third reason would be if the trader wants to turn his trading into a business where he takes on outside investors. It always is best to show the true performance of the trading approach and that you actively monitor and control errors.
Independent traders are, in effect, small businesses. Anyone who runs a successful small business knows they have to control costs. Errors in a trading business are like spoilage in the restaurant business: Unnecessary costs that could be minimized through more diligent monitoring.
It is acceptable, although not always easy, to set up an independent error account. As long as both your trading account and error account are registered in the same name and social security number and are with the same clearing firm, you can move trades from one account to another. Of course, you could avoid the hassles of an error account and accomplish much the same by logging your trading and errors separately in the right spread sheet software.
So how would an error account work? Let’s say on Friday, Dec. 30, 2011 a trader was short 10 March 2012 S&P 500 futures contracts from 1260.00 and wanted to cover that short at 1255.00. The only problem is our hypothetical trader hit one too many zeroes and bought 100 instead. If our trader sold out the extra 90 contracts at 1254.00, he could then put those in his error account along with the extra 90 contracts from the first order. “The cost of trading” (above) shows the price tag of this blunder. That trader’s trading account would show a trading profit of $12,500. However, the sloppiness in execution cost him $10,000. This trader needs to work on creating safeguards. If he has a common order size, say 10 contracts, that would be locked in and he should not need to enter size for each order and risk a fat-fingered error. And, there always should be a maximum order size. It also is an extreme example. Even with an avoidable fat-fingered mistake, he should have been able to get out immediately with a couple-of-tick loss instead of a full point, and managed to salvage some of the profit.