How Algorithmic trading can revolutionize stock market trading in India

The stock market is full of opportunities. Yes, there is nothing like holding a stock with conviction and watching it turn into a multi-bagger.

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But, as the stock market has evolved into a big complex beast, several alternate anomalies can persistently generate returns, like capturing a short-term trend or reversal pattern or using options structures to gain from short-term movements.

If you've tried these strategies manually in the ever-expanding market in terms of size and volume, there's a very high chance that you stopped in frustration.

But, if you enable your trading with technology and automation, you'll see that you can ease your burden of trading and make it as comfortable as watching grass grow or watching paint dry.

That, in a nutshell, is the value proposition of Algorithmic Trading, and it will be revolutionary for the stock market as Indian markets become more and more developed.

Sonam Srivastava, Founder, Wright Research, SEBI Regd. RIA, decodes how Algorithmic Trading is picking up with retail investor community as well and its impact on stock markets:

Of course, Algorithmic Trading is not new in India, but it is still in its nascent stage. Algos account for 70-80% of overall market volume globally and has various evolved structures, regulations, and participants, whereas algos are still doing only 50-60% volume in India and are relatively simple and less understood.

Algorithmic trading only started in India around 2010 and was initially exclusively used by Institutions and brokers. But recently, with the growth of digital discount brokers and API solutions, the retail market has open access to creating algorithms, and the opportunities are endless!

The practitioners of Algorithmic trading are growing, and the awareness and education are getting more and more structured.

However, still, there is a tremendous scope of growth for Algos in India when you compare the penetration with global markets.

Algorithmic trading is transformative in many ways - apart from profit opportunities for the trader, the algorithm makes trading more systematic by ruling out the impact of human emotions and errors on trading activities. It also makes the market more efficient and liquid.

The primary reasons algorithmic trading takes over manual trading are - speed, accuracy, and cost savings. Algos can find patterns and trade-in fraction of seconds - faster than human perception, and when the machine follows predefined instructions, accuracy and precision are advantageous.

In addition, the algo monitors your orders continually without your oversight which leads to considerable time reduction for trading lowers transaction costs.

Types of Methodologies:

Systematic trading is the form of algorithms that typically interests the majority. Trend watchers, hedge funds, and pairs traders find that programming their trading rules and automatically letting the software trade is far more efficient.

But apart from that, a vast area of trading where algorithms are used is Execution and Arbitrage. Mutual Funds, pension funds, and insurance firms deploy algorithms to slice their orders when they don't want to impact stock prices with discrete, large-volume transactions.

And there is arbitrage - buying and selling instruments that are highly correlated to make little money from the spread consistently and making the market more efficient in the process.

These algos can be high frequency - trading in milliseconds, or medium to a low frequency - trading every few minutes or even days!

The significant categories of algos are - Trend following or momentum and Mean Reversion or range-bound trading.

Smart Beta - collecting investing in market inefficiencies in a rules-based manner is gaining population in India. Arbitrage and Market Making - a method where you trade on both sides of the book are used by High-Frequency traders.

Regulations & Way Forward:

Along with expanding markets, regulations for Algorithmic Trading are also evolving in India. Recently SEBI has floated a consultation paper to make the regulations for automated trading more robust and beneficial for the end customer.

Like any developing industry, Algos have had their share of inefficiencies like the Colocation scam or predatory practice of some algo traders.

But as the industry gets wider recognition, the inefficiencies would come under control, and algorithms would revolutionize the markets with efficiency, unbiasedness, and data-driven decision making.

(Disclaimer: The views/suggestions/advices expressed here in this article is solely by investment experts. Zee Business suggests its readers to consult with their investment advisers before making any financial decision.)