The advent of Algorithmic Trading happened in India back in 2008, when the Securities and Exchange Board of India (SEBI) allowed stockbrokers to offer Direct Market Access (DMA) to their clients. Since this change took place in the middle of a global recession (2008), it swept the entire banking and securities market.
So, what is algorithmic trading? In very simple terms, it involves the use of technology and programming to automatically buy or sell the securities. Normally, these tasks are performed by humans; tasks such as analysis of companies, sectors, businesses, prices and other data. They then decide when to buy or sell. But this data can be automatically analysed by a computer as well, and that too in half the time.
At first, algorithmic trading was just used to perform simple tasks faster, like buying something on one exchange and selling it on another, and capturing the difference as arbitrage profits. As time progressed, algorithms got more sophisticated and complex, using ‘futures’ or ‘options’ for creating profitable trades that enter and exit in milliseconds. Now, modern programs can place trades and manage diverse portfolios with minimal human supervision. In the vast forex markets, which run 23 hours a day, algorithms account for about 80% of the trade volumes. The cherry on the cake is that these algorithms could generate profits at a frequency and speed that is humanely impossible to reach.
Ever since then, exchanges have been making more and more changes to accommodate such automated trading. Even the brokerage industry has effectively lived up to these rapid changes. They have introduced easily understandable automated softwares, and have also provided interfaces (APIs) that could place orders for traders.
It is expected that the global algorithmic trading market will grow significantly between 2018 and 2026, mainly because cloud-based services for algorithmic trading will start appearing in the markets, fuelled by the increasing demand for Artificial Intelligence (AI). AI helps algorithms adapt to the market conditions by learning from their past experiences, hence reducing risks while making trading decisions.
Industry reports suggest global algorithmic trading market size is expected to grow from $11.1 bn in 2019 to $18.8 bn by 2024, expanding at a compound annual growth rate (CAGR) of 11.1%
37% of financial institutions in India have invested in such technologies, and 68% plan on doing the same in the coming year, according to a survey conducted by Coherent Market Insights. It is clear that the future of trading and dealing is in automation. Upcoming traders will be expected to have at least basic knowledge of how these algorithms function and how to use them.
Complex algorithms, at some point, will take over the Indian stock markets. In the light of these advancements, some tough questions need to be asked and answered such as, would it be fair for a few well-heeled market participants to secure undue advantages with the help of such technology?
While it is clear that ‘fintech’ is the trend nowadays, it is just as easy to abuse this technology and to take things to the extreme, to set off something called predatory algorithms.
So what are predatory algorithms? They are algorithms that prey on other algorithms. For example, some might detect that a particular algorithm is selling a large stock in small bits and pieces. After detecting it, this predatory algorithm will take advantage by running ahead of it. Some algorithms might simply create artificial price signals to distort the design of some other algorithm. This had happened with a trader in London, where he spoofed over 150,000 orders. This resulted in a major ‘flash crash’, where algorithms lost their footing, and the trader earned around $40 million. However, these trade orders were cancelled immediately, hence nullifying the effects and stabilising the markets.
It is clear that technology is an opportunity, that, at least in finance, provides a direct link to profits. One can use it for the greater good: to involve more people, to reduce costs and to save time. But one can use it for evil as well, and if they’re cunning enough, they might just get away with it. The real challenge for Indian stock markets will be to find an equilibrium between these sides of the coin, an equilibrium which is fair to all participants in the market.
Kimaya Patil (Sri Venkateswara College, Delhi University, B.Com, Second Year)
References:
· https://www.livemint.com/market/stock-market-news/algos-are-changing-india-s-stock-markets-11578840300963.html
· https://en.wikipedia.org/wiki/Algorithmic_trading
· https://www.coherentmarketinsights.com/market-insight/algorithmic-trading-market-2476
· https://www.capitalmind.in/2020/02/algos-are-changing-indias-stock-markets/
· https://www.moneycontrol.com/news/business/markets/algo-ready-algorithmic-trading-4203011.html
Comments