Understanding Algo Trading And Its Future In Retail Investment

4 min read

You might not realize 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.

Stock market is also not untouched from 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 everyday.

History of Algo Trading in India:

SEBI 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, 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, futures and options but cost effectiveness and better execution were the key features of algorithms which brought algo trading to every investors desk including retail/individual investors. Today, in India, approximately 55% of the trades are placed via algorithmic trading and is expected to grow by another 15% in the near future. Let’s understand what exactly is Algorithmic Trading?

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 the factors such as volume, timing, and price. After analyzing 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.

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

In case any trader has its own trading strategy and wants to try its fate with his own 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 all 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 ShareIndia is one of them.

Why should Retail Investors choose Algo Trading?

Retail traders are the ones which had 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 an upper hand over manual traders. Hence, retail traders are showing interest in algorithmic trading and companies like ShareIndia are supporting retail algo traders with cutting-edge technology.

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

1. Increase the speed of execution:

The main reason is if you are trading a strategy which is profitable for you, you need to be able to increase the speed of execution for making the profitable trades happen quickly. It’s important to have trade at the price you set in the strategy. Algos help you trade exactly when you wish to trade.

2. Increase your market reach:

Algo trading helps you in increasing your market reach, as already discussed the algos can run strategies simultaneously across different markets which are beyond the capacity of a human.

3. Help make trading systematic:

With the 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 take decisions and execute trades based on market movements quickly and effectively. So, the need to continuously monitor the market manually during trading hours is not required.

It cannot be denied that algo trading has surely changed the Indian Stock Markets more efficiently and liquidly and is evident from the rising volumes of demat accounts owned by retail trades and Algo Trading is definitely here to stay. With ShareIndia, you can trade seamlessly with its user-friendly cutting edge technology. ShareIndia 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 Buisness on ShareIndia Youtube Channel.

https://www.youtube.com/watch?v=hnfr3c8r2Ck

https://www.youtube.com/watch?v=rTPxwaFwgZo&t=216s

https://www.youtube.com/watch?v=6i4EiL8Cb38&t=131s

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

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