Algo trading: Sebi proposals and market concerns
- SEBI recommended that all orders generated by application programming interfaces (API) of stockbrokers be considered as algorithmic trading, or algo, raising concerns that such regulations will hinder the expansion of algo trading in India.
- Algorithmic trading refers to the automatic execution of trade orders created at ultrafast speeds using powerful mathematical algorithms.
- Algorithmic trading, or algo trading, is a type of trading that monitors current stock prices and makes trades based on a set of criteria. This strategy eliminates the need for traders to constantly watch stock prices and place orders.
What is the purpose of API?
- Many Indian brokers have begun to provide their clients access to an Application Programming Interface (API), which establishes an internet link between a data source (stock broker) and an end-user (client).
- API access allows investors to utilise a third-party application that meets their feature requirements or to construct their own front-end features if they have the technical skills.
- Investors can use these third-party tools to analyse market data or back-test trading or investment strategies.
- Investors use these APIs to automate their trading. While the broker can now identify orders coming from an API, they are unable to distinguish between algo and non-algo orders coming from the API.
The Need for Formulating a Regulatory Framework
- All orders emerging from an API should be handled as an algo order and be subject to regulation by stock brokers.
- The APIs used to conduct algo trading should be labelled with the unique algo ID issued by the stock exchange that granted the algo approval.
- All algos must be approved by the exchange before they may be used.
- Each algo strategy, whether utilised by a broker or a customer, must be approved by the exchange, and each algo strategy must be certified by Certified Information Systems Auditor (CISA)/ Diploma in Information System Audit (DISA) auditors, as is standard procedure.
- Stock exchanges must create a mechanism to verify that only those algos are deployed that have been approved by the exchange and have a unique algo ID issued by the exchange.
- All algos designed by any organisation must operate on broker servers, which have control over customer orders, order confirmations, and margin information.
- Every system that grants access to an investor for any API/algo trade should provide two-factor authentication.
- While investors (particularly retail investors) are increasingly using the services of these third-party apps or algo providers and vendors, such algos based on APIs are being installed without obtaining the necessary permits from the exchanges as required by the existing regulations.
- When it comes to algos used by ordinary investors via APIs, neither exchanges nor brokers can tell if a trade coming from an API connection is an algo or a non-algo trade.
- Unregulated and unapproved algos are a concern to the market since they may be used for systematic market manipulation as well as to entice regular investors by promising bigger profits.
- For ordinary investors, the potential loss in the event of a bad algo strategy is enormous. Because these third-party algo providers and vendors are unregulated, there is no way for investors to file complaints.
- Algo trading will help ordinary investors who aren't full-time stock traders by deepening the stock markets.
- Since obtaining the necessary clearance from stock exchanges is a time-consuming procedure, brokers may be forced to abandon the API system.
- However, if APIs are not permitted, investors may go to another system, and ""placing limits on the market will damage development.""
- ""It will ensure that retail investors' interests are safeguarded, and it will increase investors' trust in algo trading.""
- There will be no price manipulations if a set of regulations is in place, and investors will not suffer significant losses as a result.
- It might also be a gift in disguise for brokers looking to improve their technology capabilities and extend their customer base.