An algo trading starter kit for those who would like to learn

• Algo trading has been a hot topic amongst traders and investors of late, thanks to the market regulator SEBI’s new consultation paper.
• With the explosion in the number of people actively participating in the markets, it is important to understand that algo trading might have an impact on your trading activities even if you don’t use it.
• If you are wondering what exactly algo trading is, here’s a simple and straightforward starter kit.

Algo trading, short for algorithm trading, is a machine-driven trading service that can either suggest trades based on the data that is fed into the system, or automatically execute orders on your behalf.

For instance, let’s assume you have come up with a strategy for a trade in a particular stock. Say, you want to sell Reliance Industries’ shares if it falls below 3% and if the sell-side volumes are higher than the 20-day moving average.

You can go to your broker’s website or app and place a ‘Limit’ order with the quantity and price details. However, you won’t be able to specify the volume condition that we mentioned above.

This is where algorithms come in – you can feed both the conditions into an algorithm and tell it what to do when those conditions are met. An order will be placed automatically based on your inputs, with the machine doing your job for you.

These are some sample instructions given to an algorithm, and these can get really complicated if you are not market savvy:

1. Invest ₹50,000 per trade, at 2:00 p.m., if Nifty is above 17,200.
2. Buy JustDial 100 quantity, equity, intraday, if the current market price is 3% higher than previous closing price, auto square-off the position at 3:15 p.m.
3. Reliance Industries, first order ‘Buy’, first order quantity 100, equity, intraday, intraday square-off ‘On’, avoid repeat order for 5,400 seconds.

Note that these instructions have been converted to simple English to make them easier to understand. The actual instruction set entered into an algo or strategy builder will be slightly different.

How do I get into algo trading?

As it goes with everything else, that has to do with money and trading, it is important to understand that you should first get proper training and understand how algorithms are designed and how they work across different trading platforms.

However, if and when you choose to start you need a programme. Now, if you are a coder, you could write one of your own. Or you could pick one off-the-shelf algos, sold by several algo trading platforms, which also provide backtesting data (past performance).

How much do off-the-shelf algos cost?

Source: Company websites

There are some who make outlandish promises, but you should not buy into their claims. The only thing that an algo can do is to follow your instructions while you do other things. It cannot guarantee any amount of profit, regardless of the market situation.

How big is algo trading in India?

Algo trading is not a new concept, but the recent explosion in the number of retail investors has given India’s market regulator Securities and Exchange Board of India (SEBI) the jitters that the retail investors could potentially end up being the bag holders in various ways – one of which could be via algo trading.

Algo trading is widely used across developed markets, and was introduced in India in 2008. In the US, half the traders by 2012 were being done via algos. In the foreign exchange markets, algos account for nearly 80% of the total trading volumes.

"Most algos happen in derivative trading and the Indian derivative market is one of the most liquid in the global market. API [application programming interface]-based trading, usually for the retail level, would be around 25%. So, algo trading currently that happens in India is around 10%, which would be as of the first half of 2021,” Abhinav Gupta, head of the Algo trading desk at Share India told Business Insider.

At the moment, algo trading is allowed by SEBI with certain conditions related to adequacy of risk management systems and annual audits of brokers’ systems by Certified Information System Auditors (CISA).

What are the risks that I need to know about?

At the outset, algo trading seems helpful since it takes away the tedious process of manually checking if your conditions are met, and then placing the order based on that.

It is also worth noting that whatever humans can do, machines can do faster and more accurately. For instance, you might take a few seconds to perform an arithmetic calculation, but a calculator will do it instantaneously.

However, one of SEBI’s biggest concerns is the rise in algo trading platforms that either promise or suggest that traders can make money if they use their platforms.

Imagine you are told that you can make money with a simple one-click service? That proposition is too hard to pass on for many non-savvy users who might truly believe the claims made by those algo trading platforms.

These unregulated algo trading platforms can oversell or missell their algorithms to unsuspecting retail investors, who could end up losing their savings. While the risk is not as huge while trading in individual stocks, futures and options carry risk that is several magnitudes higher.

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