Emotions can interfere with and influence the decision-making of even the most learned traders. Many traders successfully write down various trading strategies, but their emotions get the best of them. As humans, it is impossible to completely get rid of emotions, which is why traders started turning to computers to automate and carry out trades. Using computers to automate trades helped build a trading system free of human emotion. In this type of trading, the computer executes the trade based on a set of instructions or algorithms provided by the trader. Hence, it is called algorithmic trading or algo-trading. Algorithmic trading in India was non-existent in the early 2000s but is gradually becoming more prominent across the country.
SEBI (Securities and Exchange Board of India) introduced algorithmic trading in India on 3rd April 2008. It did that by providing institutions with the Direct Market Access (DMA) facility. This facility lets brokers share technological infrastructure with their clients and gives them direct access to the exchange trading system. That allows the broker’s client to use programs and algorithms to place trades. However, because only institutions had access at the time, algo-trading was limited to institutions in India.
The Direct Market Access feature ended up being very beneficial to the institutions. It drastically helped lower the costs incurred to trade in the Indian markets. Both FIIs (Foreign Institutional Investors) and DIIs (Domestic Institutional Investors) requested to use the service. That included institutions like Morgan Stanley, DSP Merill Lynch, JP Morgan, and Credit Lyonnais Securities Asia (CLSA). They ran test runs of the Direct Market Access software to keep it identical to the systems at the stock exchanges. Back then, retail investors in India did not have the privilege to trade using algorithms. However, the privilege was eventually made available to retail investors.
The Direct Market Access facility was just the start, and it paved the way for smart order routing, high-frequency trading (HTF), co-location, and practices concerning algo-trading in India.
Smart order routing is an algo-trading process that follows a set of rules to execute the best orders across different exchanges. In contrast, high-frequency trading involves a computer program that is instructed to perform trades on very small time scales. Trades are executed within milliseconds or even nanoseconds. Lastly, algorithmic trading in India also gave rise to co-location services wherein members could place their servers on the stock exchange’s premises. Co-location helped facilitate high-frequency trades.
Now, let us look at how you can start algorithmic trading in India. To start algo-trading, you will need to possess knowledge in the following domains.
As you know, algorithmic trading is performed by computers based on the instructions entered into the system. Those instructions are entered into the computer in the form of computer code. In other words, you write code and develop software that is capable of trading in the capital markets based on data imputed. Hence, you need to know a computer language like Python or C++. If you do not possess programming skills, you could hire a professional who can program the trading algorithm.
Analytical and Mathematical Skills
Besides knowledge about computer programming, it is also essential for the investor to have analytical skills. That is because you have to analyse a large set of data and identify certain patterns before you can write code to program an algorithm to trade using that software. And since the fundamentals of analytical data and algorithms are based on mathematical functions, you also must have a robust understanding of statistics and calculus.
Finally, you must also have a thorough understanding of the financial markets. As an algo trader, you program an algorithm to automate your trading setup, but that does not imply you can skip classes on the capital markets. Only if you comprehend the different facts of equity, derivative, and commodity markets can you come up with effective trading strategies. Then, you automate those strategies with the help of computer programming. Whether you wish to trade normally or with the help of algorithms, some important market concepts must be written in stone. You cannot design algorithms if you do not understand the financial aspects of the markets.
If you are well versed in all three domains mentioned above, then you should have no trouble backtesting to find out the efficiency of your strategy. The process of backtesting involves applying your trading strategy to historical data. You could develop a program to backtest your data as well. Besides knowledge in the above-mentioned domains, skills like logical thinking and econometrics are also beneficial.
How do you learn the skills needed to start algo trading in India now that you know what they are? You can consider opting for algo trading courses on online platforms like the BSE Institute, CFA Institute, WorldQuant University, and QuantInsti. At the same time, you can also learn it by yourself, provided you have the time and are willing to dedicate yourself to learning algo-trading.
If you have zero knowledge of computer programming or statistics, consider learning a computer language. There are plenty of online courses to help you do that. On the other hand, you can start learning about the stock market by taking online courses and reading blogs on the Internet. It would also be in your best interest to read books on investing and trading by famous stock investors. Once you understand the basics, you can proceed to focus on creating algorithmic trading strategies.
Moving to the regulations on algo-trading in India, as per rules laid down by the SEBI, there are three things you need to take note of.
- First are the audit requirements that require every algo trading firm to go through half-yearly audits conducted by approved auditors.
- The exchange also requires you to comply with some regulations regarding order execution.
- Lastly, you also have to comply with some additional regulations if you plan on trading using algorithms in the commodity market.
The future of algorithmic trading in India looks bright, as many brokers, including Share India, are working towards introducing algo trading to more people. India is already estimated to have 50–60% penetration of algo-trading, but this figure is mainly composed of institutions. At the same time, developed economies like the US see a high proportion of algorithmic trades. That said, in the future, we can expect to see more traders move to algorithmic trading as it becomes more accessible due to technological advancements. Furthermore, in the regulatory framework for algo-trading in India, it’s important to consider risk management measures, including strategies to address slippage trading, ensure compliance with SEBI guidelines, and safeguard against unexpected market fluctuations.
Frequently Asked Questions (FAQs)
Yes, algo-trading is completely legal in India, and it does not matter whether you are a retail investor or an institution.
Yes, as a retail investor, you can get hold of a broker to get access to algo-trading. However, not every brokerage house provides algo-trading services, so you will have to do your research well before you start opening an account with a stockbroker.
As a retail investor, the approval process is quite simple if you avail of algo-trading services through a broker. That is because the broker will request approval from the authorities on your behalf.