With the capital market regulator expressing concern over algorithmic trading ? popularly known as algos ? stock exchanges have swung into action by putting in place risk-control measures to avoid non-genuine algos from flooding the trading systems.
According to market participants, exchanges have started implementing controls in the form of order-to-trade ratio to deter entities from executing algos that have a wide disconnect from the prevailing market scenario. An order-to-trade ratio refers to the number of orders required to execute one trade – higher the number, less efficient is the algo.
Late last month, NSE announced that if the order-to-trade ratio is 500 or more during a trading day, the member will not be permitted to place any orders for the first 15 minutes on the next trading day as a cooling-off action. The exchange, however, has allowed such entities to enter transactions in risk-reducing mode in the respective segments during the cooling-off period.
?Some kind of differentiated cost for high order-to-trade ratio is very common across the exchanges worldwide… such costs or other actions are necessary to offset high loads put on the exchange matching engines,? says Sandeep Tyagi, chairman and managing director, Estee Advisors, a Gurgaon-based quant investment firm.
Market players say that such kind of risk-control measures are quite common in the developed markets where the share of algos in the daily turnover is much higher than that of India. Rough estimates put the share of algos in India in the range of 6-7% of the daily turnover.
Experts, however, also point out that in the case of illiquid counters, a high order-to-trade ratio is unavoidable as there is a need to maintain quotes without getting execution. Strategies acting as market-makers should have higher thresholds than other strategies, says Tyagi.
Algos refer to software programmes that execute trades as and when the pre-set defined parameters are triggered. So, for instance, a software code can execute a buy and sell order when certain price parameters are triggered. Also, the volume can be set and the whole transaction executed without any manual intervention. Complex trading strategies can be implemented using algos.
Meanwhile, NSE has also put in place slab-based monetary penalties that are computed at member level on a daily basis. So, if the order-to -rade ratio is, for instance, 300 or 400, there would only be a monetary penalty and the member will be allowed to trade.