Trends. Make algos your trading partner

Are you a poor little rich boy looking for some excitement? What better way to add some zing to your life than taking a plunge into the swirling eddy of stock trading. And it does not have to be the boring old-world trading either, where you sit glued to the trading terminal scouting for trading opportunities. You can use a trusted assistant — trading algos — which can spot trades, initiate and close them as well.

Almost a third of the traders in India are now using computer programmes for trading. In developed countries, the share of such trading is much higher with programme-driven trades accounting for around 70 per cent of equity trading in the US and 40 per cent in Europe. 

So if you have a yen for stock trading, try trading with the help of computer driven-algos. It can be your very own genie in the box that makes trading a lot easier.

How do algos work? Some programmes slice a large order and place it through the trading session at the right time and rate. Another kind of algorithm identifies price anomalies between the price of an asset over different platforms and execute trades to exploit these differences. These programmes act like conventional arbitrageurs. There are algos that follow a set of technical parameters to buy and sell.

These are the more straight-forward and ethical algos. Indian markets have only these staid, plain vanilla kind of algos, thanks to the strict oversight of our regulators. In other markets, algos are quite evolved and in some ways quite evil. Take for instance programmes that sniff the orders in other systems or algos that make bluff trades so that other programmes reveal their intended trades.

Algos in India

What kind of algos are used in India? Trivikram Kamath, Executive Vice-President & Head - Operations, Finance & Technology, Kotak Securities explains that in the cash market in India, algos are used to execute trades closest to volume weighted average price (VWAP) or time weighted average price (TWAP). That is, an investor can use these algos to put in buy or sell orders at rates where the maximum volume was transacted or when the volume was the greatest. These programmes can be used by large institutional investors too, to buy and sell at the optimal rate. It reduces the burden on the dealer who has to constantly monitor stock prices to execute a large order.

Some algos do smart order routing (SOR) that compares rates across exchanges and puts in the trade in the exchange that has the most favourable rate.

The popular algos in the derivative segment spot price difference between cash and future price of a security or the calendar spreads of derivatives and execute trades based on these anomalies.

Institutional clients may have their own proprietary algos.

The cost that a trader or an investor incurs varies according to the needs. “Arbitrage strategies which are latency (or time) sensitive would work well if the trader buys a rack space on the exchange. Keeping your servers on the exchange rack drops the execution speeds to micro seconds. The running cost can then be ₹30-40 lakh a year. This cost can shoot up based on the kind of switches and servers being used,” says Nithin Kamath, Founder & CEO, Zerodha.

“But if the strategies don't rely on speed, you can run the strategy on the broker’s server setup or even on your personal machine. The running costs can then be between ₹3,000-30,000 a month or more depending on the setup.”

There are specialised software by Flex trader, Omnesys/Thomson Reuters, among others. But a person wanting to do automated trading does not really require these. If a strategy can be designed on an excel sheet, even this can be used to automate. To connect the excel or the programming language to the execution management system, you could use application programming interface, if the broker provides it.

In 2008, direct market access (DMA) was introduced in Indian markets where some of the large institutional investors could directly punch in orders into the exchange server without having to go through an intermediary.

DMA is especially useful for automated trading wherein programmes can directly execute orders without being routed through stock brokers.

Exchanges then made collocation facilities available that enable trading members to buy rack space on the exchange servers. By moving close to the exchange servers, the speed of orders can be increased manifold, thus giving a leg-up to algos that depend on latency or speed.

“But DMA is available only to institutional clients,” says Kamath. “For all other clients, direct access is through internet trading. So when we talk of algos with DMA, they are restricted to institutional clients or to proprietary trades of a member.”

If you are a member in any of the exchanges, you can buy rack space and put in proprietary trades from these collocation facilities.

But if you are an individual HNI investor, your broker could allow you to park your algo on his server to speed up the transactions.

Algo trading has gained a certain degree of notoriety as many of these programmes can have programming bugs. One instance of such a programming bug running amok was in Knight Capital.

This company made software to trade on a new electronic platform launched by the New York Stock Exchange. As soon as the programme was switched on, Knight Capital started losing money at the rate of $10 million every minute. At the end of 45 minutes, the company had lost $440 million.

There was a similar glitch on the Bombay Stock Exchange (BSE) in the Muhurrat session of 2010.

The algorithm of a Delhi-based share broker got into a loop, buying and selling repeatedly resulting in the BSE derivative turnover shooting to many times its daily average. The BSE had to annul all the trades made in that session.

But the market regulator, SEBI and the exchanges, aware of the damages these programmes can cause, have strict rules about the kind of algos that can be used in India. All these programmes are tested by the exchange before they can be used.

You can however leave the hassles relating to obtaining clearances to your broker and get down to making your genie rake in the moolah for you.

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