What is Algo Trading?

Algorithmic trading or Algo trading is computer assisted buying and selling of stocks. It is also known as automated or programmed trading since pre-programmed computer strategies execute buy and sell trades depending on set parameters, instructions or market pattern and conditions. Algo trading came to India in 2008, but only savvy traders were using it then. Retail traders have started using advanced algos for trading mainly in the past five years.

How does it work?

The key purpose of algo trading is speed of order execution. It takes several seconds when humans punch buy and sell traders. But algos execute orders according to predefined market conditions even before humans can think of executing trades. Traders can deploy their pre-programmed algos by connecting them to a broker's trading terminal, which is in turn is linked to a stock exchange server. Before algos came into play, retail traders had to either call their brokers to execute trades or be physically present at the nearest broker's office. Mobile trading is also a form of algo trading, where orders are executed via apps. Order execution without human intervention is an advanced form of algo trading.

How prevalent is it in India?

Around 50 per cent of the daily trading volume in Indian stock markets is through an advanced form of algo trading where computer programmes execute trade orders based on pre-defined strategies. Dozens of third-party algo programmers now sell their buy and sell strategies to clients and retail traders are increasingly using these off-the-shelf products.

Why is SEBI trying to regulate Algo Trading ?

SEBI and stock exchanges regulate and monitor broker terminals, but the algo programmes deployed by traders did not require any exchange approvals so far as there were no rules. But SEBI now believes that unregulated/unapproved algos pose a risk to the market and can be misused for systematic market manipulation as well to lure retail investors by guaranteeing them higher returns. The potential loss in the case of a failed algo strategy is huge for retail investors. Algo programmers sell their strategies like assured return products. Algo trading became controversial in 2015, when it was revealed that NSE gave preferential access to a few algo traders.

How does it propose to do it?

SEBI wants every algo trading strategy and programme to be approved by the exchanges before they are deployed by traders. SEBI has also said that there should be clarity on whether the services offered by third-party algo providers are in the nature of investment advisory services based on research and analysis done by them. SEBI wants the exchanges to develop a system to ensure that only those algos which are approved and have a unique ID are deployed.

Will it hurt volumes at the stock exchanges?

Brokers say algo trading volumes could fall once the proposed SEBI norms are implemented, since approval of pre-programmed trading strategies could be a complex affair. It is largely believed that not all algo strategies will be approved by the exchanges due to their complex nature. Also, submitting algo programmes to exchanges for their approval, would mean that vendors may have to reveal their formula.