The surge in new investors entering the stock market, which began during the pandemic, shows no signs of abating. The number of active individual investors trading on NSE reached an all-time high in December 2023 with 1.26 crore active retail investors in the cash segment and 42.5 lakh active investors in the futures and options segment. Of concern is the fact that many of these investors are succumbing to illegal get-rich schemes and guaranteed return products. Many also apparently trade with the help of unauthorised trading algorithms.
Against this background, the market regulator Securities and Exchange Board of India’s (SEBI’s) proposal to regulate algo trading platforms and make it mandatory for brokers to get the algo strategies being used by clients approved by exchanges, appears a good step. Not only will this protect investors from fly-by-night operators, but it will also help prevent trading disruptions. Earlier, algo trading was predominantly done by institutional investors or stockbrokers trading in their proprietary accounts. According to SEBI regulations, the algo programmes used by investors had to be submitted to the exchanges for their approvals and any changes to the programme also had to be ratified. While larger investors could be following these rules, smaller investors are unlikely to be doing so.
Algo trading has become increasingly democratised of late with many brokers providing an interface for investors to programme their algos and execute them on the exchange. Many platforms allow investors to code their algo programmes and run them on exchanges through a broker’s interface. The point is that with algo trades accounting for around 50 per cent of trading in equity derivatives segment and over 65 per cent of cash market trading, it would not be right to place undue curbs on them. They should be allowed to grow, but with sufficient checks. SEBI’s approach in asking these algo platforms and the algo strategy provider to register with it is the right way to regulate. This way, their activities can be supervised and the more risky or speculative algorithms rejected.
Making the algo strategy providers pass an entrance exam will ensure that only skilled strategy providers operate in the market. While brokers should not be stopped from providing APIs (application programming interface) to their clients, the algos created by clients should be ratified by the broker. Giving free access to clients to run their algos, can result in trading disruptions, if the algos flood the system with orders or enter orders far beyond the market price. The SEBI chief had recently expressed displeasure at some of the algo strategy providers guaranteeing returns of up to 300 per cent in order to lure investors. Getting the claims of these algo providers substantiated by a performance validation agency can put an end to such tall claims. Better still, registered algo strategy providers should be stopped from guaranteeing returns.