There has been a significant rise in the number of traders and investors in India over the past couple of years. This increase is attributed to the increasing awareness related to stock markets as well as the ease of transactions against the backdrop of technical advancements. There is a segment of traders that heavily relies on algo trading for their day-to-day transactions in the stock markets and earn decent returns. But what is this algo trading and how is it shaping the Indian stock markets? The details of the same are given hereunder.
What is algo trading?
This form of trading is not as new to the Indian stock markets and was introduced in 2005 but was primarily used by hedge funds and large institutional traders. However, with the increase in the number of average traders in the market today, algo trading is widely used in the country by even the high-frequency traders and smallest traders.
Algo trading refers to the use of algorithms and automated trading systems for executing trades. It involves the use of mathematical models in making buy and sell decisions for securities in real time. Algo trading is based on real-time market data and pre-set rules of trading as per the guidelines of SEBI. Its need and popularity are due to its design which minimizes the time lag between identifying a trading opportunity and executing it. It is instrumental in helping traders gain maximum advantages the market volatility and fast-moving market conditions.
History of algo trading India
The use of algo trading in India dates back to the 2000s when the SEBI legalised the its use for the execution of trades in 2008 and DMA (Direct Market Access). This opened the gates of high-frequency trades in the Indian stock exchanges enabling enhanced participation of traders. In 2010, large institutional brokers were permitted to co-locate their trading server on the exchange premises which gave them an edge of a millisecond over normal investors. In India, more than half of the trades carried out on NSE and BSE are done using the algo trading.
What are the algo trading strategies?
Traders and investors can use multiple algo trading strategies to create a successful trading portfolio. Some of the commonly used strategies are given below.
- Trend Following
This is a simple strategy that involves identifying and following market trends through algorithms. Traders then use this real-time data to buy securities that are moving up in price and sell those that have a downtrend. Trend following strategy can be used in multiple securities like stocks, commodities, currencies, bonds, etc.
- High-Frequency Trading (HFT)
Algo trading is used to process huge volumes of data in real-time to enter trades at high frequency and execute them in a fraction of a second. This strategy involves taking advantage of small discrepancies in the price of securities and profiting from them. HFT can be used for a variety of securities and market conditions taking advantage of the market volatility and speed of price fluctuations.
- Statistical Arbitrage
This strategy involves taking advantage of price discrepancies in a single security on different exchanges or between two or more securities. Traders use these price differences based on real-time data and make gains by simultaneously buying and selling the target securities.
- Mean Reversion
This strategy is based on the premise that security can have highs and lows at different points but will eventually revert back to its mean average. Mean revision uses the algo trading to identify the deviations for the mean price. Traders can buy securities that are undervalued in comparison to their historical average and sell securities that are overvalued in comparison to their historical average.
What are the pros and cons of algo trading?
The concept of algo trading is not new in India and has gained huge popularity over the years. Some of the key benefits and shortcomings of using algorithmic trading are highlighted below.
- Increased efficiency
Algo trading not only helps in faster execution of trades but also makes it more efficient. There are reduced human errors which is a common limitation of manual trading. This allies the traders to tackle market fluctuations more efficiently.
- Cost savings
It uses softwares for identifying patterns and profitable trading opportunities. This also eliminates the intermediaries that traditionally help in curating a portfolio thereby ultimately reducing the cost of trading.
- Reduced impact of emotions
One of the key rules of trading is to avoid human emotions while entering any trade. Algo trading eliminates human emotions such as fear and greed while taking any trade position and ensures a disciplined and consistent format for trading.
- Improved access to global markets
Traders can access the global markets easily through algo trading. Traders can take advantage of the multiple trading opportunities and make a successful trading portfolio.
Algo trading is quite a technical concept and requires the ability to create and implement complex algorithms as well as a deep understanding of financial markets. This makes it quite challenging for an average trader to rely solely on this way of trading without any help from professionals to identify and execute successful trading positions.
- Dependence on technology
There is reliance on technology and computers, making it vulnerable to technical issues, such as software glitches or system failures, which can have significant consequences in the fast-paced world of algorithmic trading.
- Limitations in functionality
ALgo traders have to function within the limits set by SEBI like circuit breakers. Such limits although for safeguarding the interest of the investors at large also limit the utilizing its maximum potential.
Algo trading has changed the way the average trader navigates the market volatility and has also helped in enhance the basic understanding movement of securities. With the growing awareness and opportunity for taking up trading as a primary or secondary career, algo trading is bound to be the dominant way that traders take their market positions and create a portfolio.
Some of the top algo trading softwares in India include Zerodha Strek, Zerodha Algos, Amibroker, RoboTrader, MetaTrader 5, NinjaTrader, etc.
Yes. Trading using algo trading can be quite profitable as it allows traders to rapidly take trading positions and also use the algorithm without any biases.
Yes. Algo trading is legalised by SEBI and can be used by traders without any backlash from regulators
Yes algo trading can be used to trade successfully in national as well as international markets