Algo, the future of trading

Vijay C Roy

Sivaanand Murugesan, 27,  software professional with a multi-national company, entered the stock market one and a half years back. Beginning with basic online trading, he has moved over to algorithmic trading, which is becomng popular with the tech-savvy investors. Also called algo trading, the technique was earlier restricted to institutions and high net worth individuals. But now the same is open to individuals too. 

Like Murugesan, many technology savvy youngsters are adopting algo trading, which deploys pre-set computer programmes executed by the investor by following a defined set of rules. These rules are based on time, price, quantity, etc. to execute trades automatically. The software normally supplied by brokers to investors and executed by the user ensures accuracy, speedy trade execution, better price discovery and risk management.

Although, the percentage of retail investors in the country embracing algorithmic or algo trading to execute trades in the stock market is still low but the numbers are increasing. If one goes by broking industry estimates, retail algo trading accounts for just about two to five  per cent of overall volumes in India. The high cost of software and lack of technical knowhow is the main reason behind less retail participation.

Algo has already rewritten the rules of traditional broking and caught the fancy of foreign institutional investors (FIIs) and high net worth individuals (HNIs). Considering technology adoption, service provider sees algo as the future.  

In developed markets like the US, more than 90 per cent of the trade (at much higher volumes) is done using algorithms. Roughly algorithm trading constitutes nearly 50 per cent of the overall trading in India. The percentage is negligible, considering the moderately low trading volumes in Indian stock markets.

Sarvjeet Singh Virk, co-founder and MD, Finvasia, “Back in the days, algo trading was a complicated and expensive proposition. It was available only to the elites of the  Wall Street, but with technology and technologically driven fintechs, it is now something that an average investor can easily get into. There are brokers and financial technology companies which provide simplified algo trading platforms to their investors to easily automate their strategies.”

But before our investors start to fancy about algo trading, it’s important to understand what exactly is algo trading and how it is evolving in India.

Science of algo 

In India, the term algo trading is still  used vaguely  by retail investors to refer to computer programmes that act as helpers in decision making. These small computer programmes are sometimes also called plugins, which in simple terms mean “Plug-n-Play”. In reality, algo trading is a noble concept. 

At the heart of it, algo trading suggests that investors should keep emotions out of their portfolio and invest based on certain pre-defined rules. It makes investing more of a science than art. So, once you define a formula or trading strategy, the computer follows the rules and invests based on the specifications.

The service providers

Retails investors have been using this technology for the past two to three years. Firms like Finvasia, 5Paisa, Zerodha Ltd, Master Trust Ltd, SMC Global Securities have started offering algo trading facilities to retail clients by providing the requisite software. Some companies allow clients to use their own algo trading strategies; other brokerages allow retail clients to select from the algo trading schemes that are pre-programmed by the brokerage itself.

In order to open an algo trading account, one has to deposit a one-time fee and then pay monthly charges ranging from Rs 2000 to few lakh. At times, the brokers provide the trading terminal with the high speed internet and the API (application programming interface).

“It is evident that transactions in the financial services space are gradually moving towards digital modes. In India, too, customers have started understanding the basics of automated trades. The trend is going to pick up soon,” says Gurmmet Chawla, director, Master Trust Capital Services Ltd.

“We see algo trading as future. In the past few years, we have witnessed double digit growth in software adoption,” says Kunal Nandwani, founder and CEO, uTrade Solutions, which provides software to brokers. 

The brokers further licence the software to their respective clients. To increase awareness, many firms are training potential clients. “We are training probable clients so that they can embrace technology. For this, we have also deployed simulators so that the client can trade on a virtual platform rather than actual trading,” adds Chawla.

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Tips to invest 

• Never fall in love with the stocks in your possession. Keep on registering profit.
• Invest only surplus funds.
• Monitor your portfolio and stock market regularly.
• Never get influenced by the actions of friends, neighbours or relatives.
• Do proper research before investing.
• Follow a disciplined approach.
• Have realistic expectations from the stocks in possession.

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Pros

Algo trading has many benefits. For example, your investments are based on pre-defined mathematical formulas. These formulas can be back-tested over decades of historical behaviour of the stock market. You can see exactly how your portfolio would have performed over these years if you had invested using that specific algo. Also, with algo trading, an investor doesn’t need to watch his portfolio all the time. The algo will monitor it on a second-by-second basis and will make the decisions on your behalf. 

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Cons  

• There are, however, some downsides which cannot be ignored. First of all, it is a complicated process to build an “all-weather” algo trading strategy. Often, algo trading strategies fall victim to ‘curve fitting’— a term used for algo traders, who build their algo trading strategies based on how the history has performed. So effectively, an algo is built based on an investor’s knowledge history rather than actual fundamental strategy that will also perform well in future. Imagine driving your car by looking only in the rear view mirror, you will know how the road has been but you cannot make the decision when to turn your car by simply looking at the road behind you.