What Is Algo Trading and How Does It Affect You?

Algorithmic or automated trading relates to using a computer program that automatically submits trades to an exchange without any human interference.

From data processing to automated reasoning, computer software can do it all, and with unmatched speed and efficiency. It is only logical, because, that they are also used for trading on the stock markets. Algorithmic or automated trading refers to using a computer program that automatically submits trades to an exchange without any human interference.

In India, algorithmic or algo trading is successful amongst institutional investors like investment banks and hedge funds and accounts for 35-40% of the turnover on the exchanges. It is usually sent out using software provided by a brokerage firm of a third-party provider.

What is it?

An algorithm is a set of instructions which a computer is programmed to follow in order to carry out a certain task. In the case of trading, these instructions pertain to set trades with speed and precision which a human trader won’t be able to achieve. The instructions automatically set the timing, quantity, price limits or any other relevant criteria that would ensure the most profitable trade. Automated trading takes human emotion and impulses out of trading by eliminating human intervention altogether.

Algo trading is used for high-frequency trading (HFT), which includes placing a large number of trade orders across multiple markets and decision parameters at a very high speed, based on preprogrammed instructions. This extends the market reach and increases the possibility of making a profit.

Algo trading has been under inspection for some time now because a probe by the Securities and Exchange Board of India (Sebi) earlier this year into NSE’s algorithmic trading platform found that some traders had illegal access to market data and trading systems.

Does it affect you?

This type of trading is popular among institutional investor across the world than retail investors. The technology requires to carry out this form of trading which is not easily accessible to small-time investors. But even if retail investors do not participate in algo trading, they might feel the impact of high-frequency trading. In the time that it takes for an investor to execute a buy or sell order, a high-frequency trading system can execute multiple trades and benefit from the final price entered by the investor. This also includes increasing market volatility since even a small fall in the market can trigger a mass sell order, leading to a crash.

At present, there are no set rules regarding algo trading for retail investors. Though, some brokerage firms offer it as a product. It is important to know that algo trading is a market strategy and not meant for long-term investors.

Algorithmic trading has revolutionized currency equities and bond markets globally, making them more efficient. In developed markets such as the US, it stands at approximately 70- 80% of the equity market turnover. Algorithmic trading in India has also increased An important point to note here is that automated trading does not mean it is free from human intervention- it just caused the focus of human intervention to shift from the process of trading to a more behind-the-scenes role, which involves devising newer alpha-seeking strategies on a regular basis, what we call "Öptimisation".