SEBI’s New Plan for Algo Trading
SEBI has introduced a new plan to make algorithmic trading more accessible to small investors, while keeping the market safe and fair. As more retail investors turn to algo trading, many unregulated platforms have appeared, making false claims of high profits.
What is Algo Trading?
Algo trading uses computer programs to buy and sell stocks based on certain rules. For example, an algorithm might buy a stock if the price goes above ₹200 and sell it if it drops below ₹190. This means you don’t have to constantly monitor the market, and trades happen quickly. However, these programs can get complex in practice.
Benefits of Algo Trading
The main advantages of algo trading are speed and consistency. Algorithms can process large amounts of data and make trades in milliseconds, much faster than humans. They also stick to their rules and don’t get influenced by emotions.
Algo Trading in India
In India, algorithmic trading makes up about 70% of the total market volume. Although it sounds like a lot, most of this comes from large institutions like high-frequency traders, not small retail investors.
Source: NSE Pulse
Source: NSE Pulse
SEBI’s New Rules for Algo Trading
According to SEBI’s latest draft rules:
- Brokers must get approval from stock exchanges for each algorithm before using it. After approval, the algorithm gets a unique ID for tracking.
- SEBI has categorized algorithms into two types:
- White Box Algos: Transparent and open for users to see and replicate.
- Black Box Algos: Private and mostly used by big institutions. These will be subject to stricter rules, including registration as research analysts and record-keeping.
How Retail Investors Can Benefit
Retail investors can now use broker APIs to automate trades without having to register their strategies, as long as their IP address is approved by the broker. These APIs follow the same risk rules as the broker’s systems, preventing market issues from too many orders. Previously, retail investors had to register every change in their strategy, but now, automated trading is more available.
Security Measures for API Trading
Brokers providing APIs must have strong security, including two-factor authentication and restricting access to authorized users with unique keys.
Monitoring Algo Trades
Stock exchanges will monitor trades after they are executed. If any algorithms are found to malfunction, exchanges can stop them immediately with a “kill switch.” They will also make sure brokers clearly separate algo orders from non-algo ones.
The History of Algo Trading in India
Algo trading in India began in 2008 when SEBI allowed institutional investors to place orders directly into exchange systems, bypassing brokers. This provided faster trades and more control. Later, exchanges like the NSE offered co-location services, allowing traders to place their servers closer to the exchange to reduce delays.
Early Days and SEBI’s Rules
Initially, algo trading was only for large institutions, like mutual funds and hedge funds. In 2012, SEBI introduced guidelines for algo trading to manage risks and prevent manipulation.
Growth of Algo Trading
In recent years, algo trading has spread to retail investors. Brokers started offering APIs, allowing tech-savvy individuals to connect their algorithms to trading systems. Platforms also emerged to help retail investors create and test algo strategies without needing coding skills.
SEBI’s Efforts to Regulate Algo Trading
In 2021, SEBI released a paper to address the growing interest in algo trading among retail investors and the risks posed by unregulated platforms. The paper suggested that all algorithms be approved by exchanges and that brokers ensure compliance. This was SEBI’s first major move to regulate algo trading for retail investors.
Ban on Unregulated Algo Platforms
By 2022, SEBI issued a circular banning brokers from working with unregulated algo platforms. These platforms had become popular by offering pre-built strategies with unrealistic profit claims. SEBI also banned performance claims for algorithms and required more transparency to avoid misleading investors. This set the stage for the latest draft rules.
Risks of Algo Trading
With wider access to algo trading, many retail investors are interested in it, but this has raised concerns about misuse. Many unregulated platforms offered pre-built strategies with promises of high returns, which can lead to losses or market issues if poorly designed or manipulative algorithms are used.
While algo trading provides speed and efficiency, it also comes with risks. Some algorithms have been misused for manipulative tactics like spoofing, where fake orders are placed to move prices. Others can malfunction, causing flash crashes or other market problems. These risks show why SEBI’s oversight is essential and why it’s been working to improve regulations over the years.
