What Is Algo Trading?

Author: Amaan Ahmad Ansari

Content Table:
·       What is Algo-Trading?
·        A Brief History
·        Indian Scenario
·        Rules introduced by SEBI
 
What is Algo Trading?
Algo- Trading is trading that is done with the help of a computer algorithm. Therefore, Algo in Algo trading stands for Algorithm. It basically uses a computer program to automate the steps involved in trading. As per SEBI, Algorithm Trading is defined as “any order that is generated using automated execution logic shall be known as algorithm trading.”  For instance, If I ask you to enter 20 orders of trade in just 10s, you will not be able to do it because it requires high speed. But If I use Algo-trading for the same task, you will definitely do it with ease.
Most people think that they can earn large profits with the mere help of Algo trading. It is not true because you have to have a good strategy to earn more profits, Algo- trading can help you to automate or autopilot your strategy.
Let’s understand it as an example, you have a strategy that whenever bank nifty goes up 20 EMA you will take the short position, and whenever Bank Nifty goes down 20 EMA you will take the long position in the Index. If you use the Algo you will easily implement your strategy without taking any stress and without entering any trades manually.
 
Benefits of Algo Trading:
1. Automation
2. No Emotions involved in the Trades
3. Quick Execution of the Trades/Strategies
4. More Accuracy in the trades
5. Back Test Capacity
6. Cost Effective
 
A Brief History
Richard Donchian was the first person who introduced the concept of an automated trading system to buy and sell securities or Funds in 1949. However, It took 2 to 3 decades to popularize the concept of Algo-trading. Hereafter, when New York Exchange understood the potential & application, it also introduced a system in 1976, which enhanced the acceptance of electronic trades.
 
Indian Scenario

Algo trading started in India on 3^rd April 2008, when SEBI allowed Direct Market Access (DMA) for the first in India. . DMA enables institutional clients to directly access the exchange trading system through the broker’s infrastructure without the manual intervention of the broker. Further, the momentum for algo trading in India was gained by the allowance of co-location facilitated by NSE in June 2010. Co-location allows broker member servers’ to be placed side by side with the exchange server in order to reduce latency. It was aimed at reducing the time taken in the transmission of data (orders) from broker terminals to exchange servers. Since speed is the key for algo trading, most brokerage firms adopted the co-location of their server terminals.
 
Rules Introduced By SEBI:
Algo trading has approx. 50% share of the Indian financial market according to the National Institute of Financial Management (2018). However, the US has 80 penetration of algo trading.
SEBI published a consultation paper in December 2021, saying it was considering regulations and sought feedback on retail investors using algo- trading tools such as Application Programming Interface (API) access. It is concerned that algo trades executed by retail investors using APIs cannot be intensified algo or non- algo by either the broker or exchange.

Some Important Proposed Rules:
1. The facility of algo trading shall be provided by the stock broker after obtaining
permission of the stock exchange.
 
2. All algo orders shall be tagged with a unique identifier provided by the stock
exchange, in order to establish an audit trail, and the stockbroker, shall seek approval from the Exchange for any modification or change to the approved algos or systems used for algos.
 
3. The stock broker shall ensure that the price quoted by the order shall not violate the price bands defined by the stock exchange.
 
4. All algo orders shall necessarily be routed through broker servers located in India and the stock exchange should have an appropriate risk controls mechanism to address the risk emanating from algo orders.

Conclusion:

No doubt that algo trading has a bright future not only in India but all over the world. There are some challenges on the implementation and regulation side but SEBI is working on it, I hope in the near future, we will have a more secure and reliable Algo system in India.

Thanks to Read my Blog.