ALGO TRADING – SIGNS OF THE TIMES

Algorithmic trading (or machine based trading based on trade signals generated from defined patterns) is an exciting new way to trade markets and has caught on big time in India as well – with new ideas to trade markets combining with friendlier, affordable technologies on offer. While retail is catching on, the institutional turnover in India, as is the case with most of the developed markets, has already seen large shift of volumes to algo driven trades with market estimates ranging from 50%-60% of orders placed.

Regulators have also become completely familiar with non HFT trading algos (The HFT – High Frequency trading- variety of Algos still remains a dark area and regulators are striving hard to control risks from these) and have therefore allowed a positive atmosphere around retail investors participating in these, introducing new regulations which are making retail participation simpler and more controlled.

Typically, we are seeing 3 different kinds of “Algo” strategies being promoted: a) Strategy owned by client and executed via APIs (Application Programming Interface) through a broker, b) Strategy owned by the broker and clients trading on their own and c) end to end handled by a complex algorithm. Each of these have their own benefits and disadvantages but it does seem that all are flourishing as client needs and experiences vary. Such “high latency algos” have a huge scope in the future as instruments become wider in nature; more complex trading strategies develop and as clients seek alternative “absolute return” targeting strategies. These tools are flourishing especially as they allow trading without emotion as well as automatically stop loss or book trades at the right prices – which is good for the client while for the provider, it sometimes means the clients continue to flourish and offer longer term continuity without losing large amounts on bad trades.

These strategies use back tested formulae to arrive at combinations of quantitative factors that may yield the most optimal “risk return” payoffs to its clients. These Algos not only automate the business of trading but also allow money management as a built in feature which ensures quick decisions on trades apart from upfront allocation of defined capital to each strategy chosen and acceptable loss levels for trades done. ‘Traders Edge’ by Prabhudas Lilladher is one of the most sophisticated tools and a completely customized front end which is helpful to retail investors.

There are risks as well. Since it is often almost completely machine driven, execution can be opaque and in addition, not having enough risk management or money management controls in place may create risks for clients. Or not spending enough time in understanding the weakness of the strategy algos involved may often mean trades may turn into a drift mode. Clients should ensure that these are in place and that the systems are reliable, with some test trades as well, before proceeding to start fulltime on any algo. This is where Prabhudas Lilladher has attempted to bring about a difference and create a niche for clients who prefer this mode of trading but want a well known brand to ensure safety and reliability of technology.