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Recently, the Securities and Exchange Board of India (SEBI) has issued a discussion paper on regulating Algorithmic or Algo Trading, or trades generated out of automatic execution and logic.
Algo Trading
- Almost everything in the digital world is based on algorithms. Algorithms leverage user data, behaviour and usage patterns, and take in pre-specified instructions to achieve certain goals.
- Algo trading refers to orders generated at superfast speed by the use of advanced mathematical models that involve automated execution of trade.
- Even a split-second faster access is considered capable of bringing huge gains to a trader.
- The algo trading system automatically monitors the live stock prices and initiates an order when the given criteria are met.
- This frees the trader from having to monitor live stock prices and initiate manual order placement.
- It’s like asking a broker to buy or sell shares at a specific time or at a certain price, except that algorithmic trading is faster – computers analyse a lot more data than a human can in a given time and have less scope for error.
- Also, significant price changes can be avoided because orders are executed within seconds.
- Thus, investors can execute more trades faster since less time is required to manually monitor, select, buy, sell, initiate order placements and so on.
Important points:
- There is a need to create a regulatory framework for algo trading.
- An API is an interface that can be used to program software that interacts with an existing application.
- Each algo strategy, whether used by broker or client, has to be approved by exchange and as is the current practice, each algo strategy has to be certified by Certified Information Systems Auditor (CISA)/ Diploma in Information System Audit (DISA) auditors.
- Stock exchanges have to develop a system to ensure that only those algos which are approved by the exchange and having unique algo ID provided by the Exchange are being deployed.
- All algos developed by any entity have to run on the servers of brokers wherein the broker has control of client orders, order confirmations and margin information.
- Two factor authentication should be built in every such system which provides access to an investor for any API/algo trade.
Significance:
- It will ensure that the interest of retail investors is protected and it will boost investors’ confidence to undertake algo trading.
- With a set of rules in place, there won’t be any price manipulations and the investors will not incur any heavy losses in the process.
- Additionally, it might be a blessing in disguise for brokers to scale up their technological prowess and expand their clientele.
Way Forward
- Regulations govern and work towards eliminating any threats to that particular market. But in doing so, it has to often stifle innovation and keep checks in place to avoid malpractices or misuse.
- It is essential that regulators are well versed in the operation of algorithms and have the flexibility to be able to engage in new legislation where required.
SOURCE: THE HINDU,THE ECONOMIC TIMES,MINT
