• HDFC
• 31 May 2018
• Knowledge Centre

HDFC, Tester

Algorithmic trading is a trading system that uses advanced and complex mathematical models and formulas to make high-speed decisions, and execute transactions in the financial markets. It is also known as algo and black box trading. This automated trading system offers a systematic approach to active trading, rather than methods based on a human trader’s intuition or instinct, making it a safer trading option.

Automated trading systems allow traders to set specific rules for both trade entries and exits thatcan be repeatedly executed via a computer. The trade entry and exit rules can be based on simple conditions, such as a moving average crossover, or can be complicated strategies that require the expertise of a qualified programmer.

Gaining ground

The largest portion of Algo trading today is high-frequency trading (HFT), which is designed to capitalize on placing numerous orders with great speed across multiple markets, based on pre-programmed instructions.

The numbers speak for themselves. Both the cash and derivatives markets have witnessed a notable increase in algorithmic trading over time. As a percentage of total trading (cash and derivatives), algorithmic trading now stands at 49.8% from 9.26% (average) in 2010, a phenomenal leap in eight years. According to NSE data, in March 2018, 44.8% of the cash market volume and 48.2% of the equity derivatives market volume was driven by algorithmic trading, trading. In March 2018, 37.22% of the trades on the BSE were also driven by algo trading.

These numbers have come in despite a very low level of awareness about this form of trading, along with the fact that there is a need for specialized skills to trade in this domain. Also, a majority of algo players trade only in liquid scrips and derivatives.

Smaller Vendors

In order to ease the methodology of trading for small and medium-sized trading members, SEBO has asked stock exchanges to introduce managed co-location services. This facility will make space available to vendors, along with providing them with technical know-how and other requisite expertise. This has been welcomed by algo solutions providers.

Changes for commodity exchanges

On 3rd April 2018, SEBI relaxed the rules related to algo trading in commodity exchanges too, by raising the limit to process orders from a maximum of 100 orders per second from the existing limit of 20 orders per second.This decision has been taken following representations from exchanges, along with the views of SEBI's sub-committee, the Commodity Derivatives Advisory Committee.‘It has been decided to permit exchanges to relax the limit on the number of orders per second from a particular UserID up to hundred orders per second,’ SEBI said in a circular.

The market regulator has intimated exchanges to make sure that they have the ability to handle the load that accompanies these transactions.
Besides this, SEBI has decided to withdraw the requirement of empanelment of system auditors by the exchanges for a system audit of algorithmic trading.

“Algorithmic trading removes emotions from trading and enables traders to stick to a plan. It also offers the benefit of faster execution. However, on the other hand, there is too much dependence on computers and programmes which have to be up and running at all times. This implies that only people with these resources and deep pockets may survive and prosper, weeding out small-time traders who are unable or do not intend to adapt to changing times,”saidMr. Deepak Jasani, Head Retail Research, HDFC Securities Ltd.

“Does it mean that the traditional concepts of value investing will soon become irrelevant? We think both will co-exist for atleast the next decade. Individuals will choose, according to their own temperament and risk tolerance, how they want to use the stock market to increase their income/wealth. Algo traders use their strategies to generate regular income, while value investors are looking to generate and amass wealth. Looking at it the other way, value investing becomes a necessity when the amounts involved are very large,” he concluded.