Is Algo Trading Legal?

Is Algo Trading Legal? Will you be stuck in any civil or criminal laws violations if you go ahead and start using algo-trading in your trades? Are there any related complexities depending on the fact whether you are a retail or an institutional trader?

Well, there could be so many confusions related to this new form of trading! Don’t worry. Let’s try to get answers to these concerns in this detailed review.

But first, let’s have a quick look at some of the basics.

Is Algo Trading Legal – Basics

Algo trading is the process by which step-by-step instructions are given to the computer system to perform trading. The instructions are given in the form of automated programs called the algorithms. Algo Trading has been successful in changing the face of trading.

It has delivered more speed and accuracy to the trading system, along with eliminating the effects of human emotions. It involves minimum to no human intervention. The trading decisions are made based on predefined instructions and strategies. The speed with which algo trading processes a trade is phenomenal and it makes a lot of difference to the entire trade.

The latency between placing the order and its execution has been minimised, therefore, the trades get executed at the price that the trader wanted to. In the traditional methods of trading, due to the time lag between placing the order and its execution, the price of the security would get changed and the trader could not get the prices that he wanted.

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Algo Trading for Institutional Investors

Now the question arises, “Is algo trading legal in India?”, and the answer is Yes.

Algo trading is not only legal in India, but to also forms about 43% of the total trades executed on the National Stock Exchange. To give you a perspective, the global average stands at 90%. However, until now, algo trading is legal only for institutional investors and the work is still in progress for the retail investors.

It was in the year 2008 that the Securities and Exchange Board of India (SEBI) allowed algo trading for the institutional investors. Since then, algo trading has grown and flourished and forms a major chunk of the trades on the Indian stock exchanges. In the years 2012 and 2013, SEBI introduced the set of guidelines for algo trading in the securities market.

The guidelines included risk management measures and other checks for algo trading.

For the institutional investors, SEBI has allowed colocation facilities so that the traders can place their servers in the same premises as the exchange, on payment of rent, so that the institutional investors do not suffer from the latency which can lead to huge losses.

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Algo Trading for Retail Investors

If the same question, “Is algo trading legal in India?” is asked from the retail investors’ point of view, the answer is unknown. There are no structured guidelines or regulations that have been set by SEBI with respect to algo trading by the retail investors.

According to SEBI, allowing algo trading to individuals will be like giving a gun for everyone to shoot. The concern that SEBI raises is that algo trading is quite technical. The trader must know the technicalities about algorithms and coding and other aspects to be able to do algo trading efficiently.

If a retail investor wishes to be involved in algo trading, he needs to go through a rigorous process of registering himself as an Authorised Person and then he needs to get a dealer terminal from his broker. The person who is expected to man the terminal is also required to have cleared NISM Series VIII certification.

However, as we talk, SEBI is in the process of making the playing field level for institutional investors and retail investors. They are in the process of coming up with the rules and regulations for algo trading for retail investors. In the absence of rules, it will create a big mess for the trading mechanism of the entire country and the prices of the securities may get negatively affected due to lack of knowledge.

In the month of August 2016,  SEBI issued a paper in which it made a proposal to strengthen the rules of algo trading and allow the retail investors. They are trying to determine the extent to which the retail investors would be allowed to use algo trading.

Algo trading gives a cutting edge to the users, however, the magnitude and the speed of the trades is so high that the regulator is not sure if the individual investors are ready to handle it. Still, SEBI is trying to bring it in and is in consolation with the brokers, public and its panels to assess the situation.

It has also asked the stock exchanges to introduce managed co-location services, wherein along with space, the retail investors will also be provided with the technical know-how and expertise.

Therefore, as of now, the answer to “Is algo trading legal in India?” Is a yes for the institutional investors, but it is still in limbo for the retail investors.

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