The Securities and Exchange Board of India recently came out with a consultation paper to open a new trading tool for retail investors – Algo trading.
Algorithm trading or algo trading offers significant benefits of timed and programmed order execution. Currently, mechanisms such as the Direct Market Access Facility exist, which allow institutional investors to trade via algorithms.
Speed, precision
Algo trading therefore offers speed, precision, less human error and the ability to execute complex strategies. Moreover, algo can also be deployed simultaneously in multiple markets over a period of time.
Algorithmic trading is nothing but any form of automated, rules-based trading where decision-making is delegated to a computer model. The model analyzes various sets of market data (such as trading volume, volume-weighted average price, time-weighted average price, arbitrage opportunities, trend following, and news sentiment, among others) to pick up trading signals and execute trades automatically.
Types of Algo
Currently, there are several types of algo trading systems, including high-frequency trading (a type of algorithmic trading that is latency-sensitive, where large numbers of trades are executed within very short time frames to take advantage of small price differences), index rebalancing (carried out prior to changes in the benchmark indices), trend following (picking up stocks/sector that are likely to trend), zero-touch algos (identifying the trading opportunity and executing it without manual intervention), etc.
“There is an increasing demand for algo trading by private investors. “To facilitate the participation of retail investors in the trading of algos, it has been decided to review and refine the existing regulatory framework to ensure proper checks and balances, to protect the interests of investors and the integrity of the market,” SEBI said .
Badly bruised
The regulator’s proposal should be seen in the background of its recent investigations into the trading behavior of private investors. According to the report, nine out of 10 individual traders in the equity futures and options (F&O) segment are still experiencing significant losses. Most of the profits were generated by larger entities using trading algorithms, with 97 percent of FPI profits and 96 percent of proprietary trader profits coming from algorithmic trading, the study further found. The total losses of individual traders stood at over ₹1.8 lakh crore during the three-year period between FY22 and FY24. The regulator also found that more than 70 percent (7 out of 10) of individual intraday traders in the equity-cash segment incurred losses in the 2022-2023 financial year.
Leveling the field
As per SEBI’s current norms, brokers need approval from exchanges to offer algo trading. They must inform the exchanges about the algo strategy and any changes therein.
All algo orders must be routed through broker servers in India. Additionally, all algo orders must be tagged with a unique identification code provided by the exchange to establish an audit trail. This allows the exchange to know whether an order is algorithmic or non-algorithmic.
There are currently several players offering algo trading to private investors. Prominent among them are Tradetron, Zerodha Streak, uTrade Algos, AlgoTest, QuantMan, Algobulls, Quantiply, AlgoMojo, Robomatic, Robo Trader, Ninja Trader and Metatrader, Narnolia, etc.
However, this time they will have direct market access just like FPIs/proprietary traders, which means they will have access to a co-location server that will enable them faster trading.
So in that sense, it is welcome to offer retail investors the opportunity to explore algo trading via DMI. This creates a ‘perceived’ level playing field for private investors.
However, will Algo trading help retail investors cut their losses if they don’t make profits?
Play it safe
It is very difficult for individual traders to make money with intraday or short-term trading. Powerful traders will always use a better tool than what is available to the individual in this zero-sum game.
So it is better to focus on long-term investments, especially new investors; index funds are the best products to explore. Furthermore, moderating expectations about market returns will protect them from greed.
Algo-hungry traders can even consider quant funds, which primarily use AI for stock selection. However, the risk in this category will be higher.
