Should we blame market fall on algo trades?

KS Badri Narayanan Chennai | Updated on March 14, 2020

Currently, about 40% trades are happening through algo-based trading on the NSE

As the markets world over crashed and ‘entered into bear territory’, a lot of marketmen took to blaming it on pre-programmed trading or automated trading using various algorithms, famously known as algo trades.

Across the globe, even in the so-called developed markets, trading was halted last week on a few occasions, as the benchmark indices hit the prescribed lower circuit. In India too, for the first time since 2008, trading was halted on Friday but bounced back sharply after trading resumed subsequently.

What is algo trade?

Algorithmic trades are orders executed on the exchange platform by computers, without much manual intervention through a programme designed by the investor. In India, algo trades were introduced in 2009. Since then, they have seen sharp rise in interest from large domestic and foreign institutions, who trade on proprietary books.

Currently, about 40 per cent of trades are happening through algorithm-based trading on the NSE.

Some algo trades involve manual intervention, but big investors mostly use zero-touch algos, which use pre-set technical levels (such as moving averages, RSI, etc) fundamental/quantitative indicators (profit margin, P/E Ratio, EPS, etc) or arbitrage opportunities (between futures and spot price) in the market. The main reason why they use zero-touch algo trading is that it eliminates emotional quotient of traders and hence execution of trades will be without any bias.

So, can algo trades influence the direction of the markets? If one believes that a huge set of predetermined orders could trigger panic selling, there would also always be a counter-party army of algos, who would resort to aggressive buying through programmed trades. That should in effect act as a counter to aggressive selling. Besides, none of the exchanges indicate any systemic risk on recent fall. That means, that execution has happened smoothly for both sellers and buyers, going against the theory of one-sided algo-trade triggered sell-offs.

This recent sell-off is mainly due to the fear of business loss on coronavirus and no one knows how big and long this will impact the economy. Virtual bans on business meetings, travelling, mall visits, etc will have far-reaching consequences. And that fear is real, and hence the big fall.

Published on March 14, 2020

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