Securities and Exchange Board of India (SEBI), the capital markets regulator, has proposed algorithmic (algo) traders in the retail segment of the stock market to get their trading strategies and software approved by the stock exchanges.
The new rules will require brokers to obtain approval from the exchange before implementing any algorithms. An algorithm, whether used by the broker or the client, must be approved by the exchange, and, as is the current practice, it must be certified by CISA/DISA auditors.
What is Algorithm Trading?
Trading algorithms (also called automatic trading, black-box trading, or algo-trading) are computer programmes executing a set of instructions (an algorithm) to place a trade.
A human trader cannot generate profits at the same speed and frequency as the trade, in theory. In this method, pre-programmed trading instructions take into account variables such as time, price and volume while executing orders.
By monitoring the live market automatically, the algo trading system determines when to initiate a long or short trade based on a set of criteria. Traders can use this service to automate their call/put actions without having to monitor livestock prices.
SEBI proposed regulating algorithmic trading (algo trading) on Thursday to make it safe and prevent market manipulations. A move like this could seriously curtail something like trading, since several strategies and software may be unable to pass muster.
Retail investors may be able to use APIs and automated trades through the framework the regulator has proposed in its consultation paper. The exchanges give approval to something submitted by brokers.
Retail investors deploy algorithms via APIs, but neither exchanges nor brokers know whether the trades emanating from API links are algorithms or not.
SEBI said that unregulated/unapproved algo trading poses a risk to the market and can be misused for systematic market manipulation as well as to lure retail investors by claiming higher returns. More than half of trading is currently done through algorithmic strategies, brokers say. Exchanges have already endorsed the broking platforms that provide clients with trading services, but the strategies created by third parties have been a gray area given that they are sold off-the-shelf without much scrutiny.
According to SEBI, there should be clarity on whether the services provided by third-party providers are investment advisory services based on their research and analysis. These algo coders must comply with the same SEBI norms as investment advisors.
Nitin Kamath, co-founder, and CEO, Zerodha, said every broker and stock exchange could lose a certain amount of business if these regulations are put in place. There are also scores of third-party vendors offering algo-based trading strategies who will be adversely affected.
