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Understanding Algo-Trading and Its Future in Retail Investment

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You might not realise it in everyday routine, but sophisticated algorithms are already dominating our everyday life through traffic lights, train schedules, your Facebook newsfeed, and more. 

Think about your favorite e-library, checking your e-commerce account’s mobile app, or checking traffic before you decide to step out of your house. All these systems smoothly operate on mathematical models called algorithms, commonly known as algos. With every click and tap you make, these algos make thousands of micro-decisions that instantly serve up the information you want.

The stock market is also not untouched by the magic of algos. The trading algorithms are already reshaping the way trading is done on Dalal Street. Investors are using algo-trading to bring greater efficiency to financial markets, and at the same time, the technology is enhancing transparency every day.

History of Algo-Trading in India

The SEBI (Securities and Exchange Board of India) allowed Direct Market Access (DMA) in India in late 2008, opening high-frequency trading (HFT) access in India to all the leading Indian stock market exchanges (HFT and algo-trading can be considered synonyms).

Again, in 2010, the National Stock Exchange (NSE) permitted large institutional brokers to co-locate their trading server in the exchange premises with a dedicated connection link from the exchange. This co-location gives a millisecond advantage over normal investors.

In the initial years, algo-trading was considered a tool only for institutional investors or proprietary desks of broking houses trading in equities as well as futures and options. Still, cost-effectiveness and better execution were the key features of algorithms that brought algo-trading to every investor’s desk, including retail/individual investors. Today, in India, approximately 55% of the trades are placed via algorithmic trading, and it is expected to grow by another 15% in the near future. Let’s understand what exactly algorithmic trading is.

What is Algorithmic Trading?

An algorithm comprises a set of instructions in order to solve a problem. Algorithmic trading is a procedure for carrying out orders using pre-programmed or automated trading commands accounting for factors such as volume, timing, and price. After analysing all the enlisted factors, signals for buys or sells are generated automatically. Once a buy signal is generated by an algorithm, the trade is executed within fractions of a second.

Algorithmic trading is all about executing trades rapidly in an automated manner at a pace that can never be done manually. Algo-trading is superior to manual trading because of several reasons.

  • Firstly, an algo-trading system can simultaneously understand multiple commands and can execute in an almost error-free fashion among multiple markets. 
  • Secondly, algo-trades help in risk management as all the ground rules are already specified. With the help of backtesting and stoploss, you are securing your hard-earned money. It also helps in overcoming the risk of fat-finger trades, which can occur due to errors in manual execution. 
  • Thirdly, algo-trading works really in repetitive orders as it can execute conditional orders at a speed that humans cannot beat.
  • Lastly, and the most important aspect of algo-trading, is that it does not get carried away with emotions, as it never experiences fear or gets greedy. 

Learn more about the benefits of algo trading and how to get started.

Now that we have clearly understood what algo-trading is, it is equally important to have a broader idea of how an algorithm is designed. Algorithmic traders usually use historical data to design and develop their algorithms. 

First of all, they identify a strategy that has a strong past record and which they believe will be profitable in different scenarios. The next step after identifying the strategy is to code it into a computer language using Python/C++/Java. Then comes the most important step, backtesting, which tests the profitability of the strategy on historical data.

In case any trader has their own trading strategy and wants to try its fate with that strategy, then they can create an algo out of their own unique strategy with the help of a professional coder.  

Risk management is critical with algorithmic trading. That is why, for any HFT algorithm to be approved by the markets, exchanges require a firm to undergo a series of stringent tests if it intends to trade through algos. These tests include the number of orders that would be placed per second, the maximum order value of any order placed, and the maximum traded quantity during a particular trading day.

Who Can Use Algo-Trading?

1. Generally, algo-trading is used by mutual funds, hedge funds, insurance companies, banks, and other institutions to execute a large number of high-volume trades that are otherwise impossible for humans to undertake.

2. Over the past decade, the rise of fintech firms has led to an increase in retail participation, and Share India is one of them.

Why Should Retail Investors Choose Algo-Trading?

Retail traders are the ones who have remained deprived of algorithmic trading for a long time. But as already discussed, algo-trading is growing at a fast pace, and not participating in algorithmic trading may lead to an impact on the retail traders because, in the market, algorithmic traders may have the upper hand over manual traders. Hence, retail traders are showing interest in algorithmic trading, and companies like Share India are supporting retail algo-traders with cutting-edge technology. If you are looking for a reliable and affordable way to trade stocks, you should consider using our online trading app.

Algorithmic trading brings the following benefits to the retail traders in the financial markets:

1. Increase in the speed of execution:

If you are trading a strategy that is profitable for you, you need to be able to increase the speed of execution to make the profitable trades happen quickly. It’s important to have trade at the price you set in the strategy. Algorithms help you trade exactly when you wish to trade.

2. Increase in your market reach:

Algo-trading helps you increase your market reach. As already discussed, the algos can run strategies simultaneously across different markets that are beyond the capacity of a human.

3. Help in making trading systematic:

With preset conditions like time, price, quantity, and some other market conditions being met with algorithmic trading, it is known to remove the subjectivity from trading patterns and make the trading systematic, ruling out the chances of traders getting carried away with emotions like greed and fear.

4. Help with eliminating constant market monitoring:

Algorithms can monitor and make decisions and execute trades based on market movements quickly and effectively. So, there is no need to continuously monitor the market manually during trading hours.

It cannot be denied that algo-trading has surely changed the Indian stock markets more efficiently and liquidly, and it is evident from the rising volumes of Demat accounts owned by retail trades that algo-trading is definitely here to stay. With Share India, you can trade seamlessly with its user-friendly cutting-edge technology. Share India also offers advanced technical analysis and charting tools to make algorithmic trading easy for you. For more insights on algo-trading, check out our expert talking about it with Zee Business on the Share India Youtube Channel.

Disclaimer: Any advice or information in the post is general advice for education purposes only and is not responsible for generating any trading strategy for anyone. Please do not trade or invest based solely on this information.