04 Apr 2018 19:55 IST

Algo trading gets a face-lift

SEBI’s recent moves will improve transparency in automated trading and widen its scope as well

The term ‘algo trading’ is increasingly associated with trading by a select group of elite traders with deep pockets and technological prowess. Many of these automated trades are executed by programs that reside in servers perched right next to the exchange server (in exchange co-location facilities). Algo trades from these facilities can be executed before other trades punch in from various parts of the country, as the distance that the data travels (latency) is minimal if trades are executed from the nearby locations.

At its recent board meeting, market regulator Securities and Exchange Board of India (SEBI) tried to allay misgivings about algo trades executed from co-location facilities. Here’s a lowdown on the changes and their impact.

Shared co-location services

The annual rent of a full rack on the National Stock Exchage’s co-location facility is ₹12 lakh, with a half rack costing ₹6 lakh. If the set-up, maintenance, connectivity and data charges are included, the rental cost could increase up to ₹10 lakh for a half rack and ₹20 lakh for a full rack.

These costs are considered prohibitive for smaller traders. SEBI now proposes to allow members to share the co-location facilities. While the contours of the sharing have to be worked out by the stock exchanges, it appears as if four or five members could share each rack. This will bring down the rental cost.

What’s in it for you: Shared colos will, however, not be relevant to smaller traders or investors who go through other brokers, for individuals cannot rent racks. They can only be rented by trading members or institutions (foreign or domestic) who have permission to directly access the stock exchange platforms.

Algo trading done by individual traders or investors involves application programming interfaces (APIs) that let them select their strategy, code their requirements and then communicate it to the broker’s interface. Once the set of instructions is keyed into the API, it scours the exchange data and alerts the trader when the price is right for the trading set-up. The person will then have to manually execute the transaction. In other words, the algos used by individuals are not dependent on the speed of execution, so there is no need for them to work from colo facilities.

Free Tick-by-Tick data

SEBI has ruled that stock exchanges have to provide free Tick-by-Tick data feed (TBT feed) to all its members. This includes all the orders keyed in to the exchange platform, along with modification of orders and the execution. In short, it includes reams of data for each minute, which the human mind is incapable of processing.

Algo trading programs thrive on this data as they need it to spot the right trading opportunity. SEBI has asked exchanges to provide this information to all members, as long as they have the necessary infrastructure.

What’s in it for you: This tweak is irrelevant to small traders. The TBT feed can be provided only to those located on the colo racks, and it is impossible for brokers to transmit all that data to their clients. So, it’s unlikely that the information will be made available to small traders or investors.

Increasing the depth of order book

The market regulator also ruled that the order book displayed on trading terminals, which now shows up to five bid-and-ask quotes, needs to be expanded. Depending on the final order, the book could display 10 or 20 quotes.

What’s in it for you: Availability of more information regarding the demand and supply of a security will help traders decide on the level at which they can place their buy and sell order.

Other changes

Other changes prescribed by the regulator, such as imposing a penalty on algo orders that are far above the market price, allotting a unique identification number for each algo and asking exchanges to disclose the speed offered by them at colo facilities, will increase transparency.

SEBI’s move suggests that algo trading is here to stay in India. With these trades now accounting for 40-50 per cent of market turnover, they cannot be restrained easily. The way forward is to increase scrutiny, tighten the regulations, and ensure that the interests of smaller players are not further compromised.