New algorithm trading norms soon

The Securities & Exchange Board of India (Sebi) is expected to announce new regulations for algorithm trading after its board meeting on March 12.

Pavan Burugula

The possible measures that could be incorporated include determination of the resting period and fixing a benchmark for order-to-trade ratio, sources told FE. These measures are expected check volatility, price manipulation and level the playing field between those using algorithms for their trades and those who don’t.

The resting period is the period after which an order punched can be cancelled. This would help eliminate fleeting orders – those appear and disappear within microseconds. The Resting period would prevent traders from cancelling or modifying an order immediately after its submission.

The order-to-trade ratio is the ratio between number of orders placed and those that get traded. These days, in order to lower the entry price, some algorithms enter big bids and immediately cancel them to create artificial weakness in a stock. By fixing a high order to trade ratio, Sebi can curb such practices.

“Sebi may fix a order-to-trade ratio and traders who fail to meet the ratio could be fined. In the aspect of the resting period, the regulator may fix resting period of 600-700 miliseconds for orders. Six hundred milliseconds is approximately the time taken for execution of an order from a non-algorithm trader. In this way there will be more parity among all the types of traders,” a former Sebi official said on condition of anonymity.

Sebi had released broad guidelines for algorithm trading in 2013. As per the guidelines, stock brokers and traders who deal with algorithm trading are required to undergo system audits once in six months to ensure that the system programmes are in line with the regulations of the Sebi or the stock exchanges .

The Reserve Bank of India (RBI) raised concerns about algorithm trading and high-frequency trading (HFT) in its annual financial stability report released last year. The RBI had observed that the complex coding and ultra-low latency increase risks of erroneous trades and manipulations in stock markets due to advanced communication platforms.

“The fact that the share of algorithm orders in total orders and the share of cancelled algorithm orders in the total number of cancelled orders is around 90% creates concerns relating to systemic risks,” the RBI said in the report.

Though some tend to categorise algorithm trading as HFT or confuse it with automated trading, there are subtle differences among the three categories. When a trader uses an algorithm to minimise the entry price or maximise the exit price in a trade, it is referred as algorithm trading. On the other hand, automated trading involves full automation and pre-programmed entry and exit in a trade. HFT is just low-latency, high-speed variety of automated trading.

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