FINANCIAL MARKETS AND SECURITIES

TERM 3
INDIVIDUAL ASSIGNMENT

Topic: Algo Trading Concepts, trends and the

regulatory environment in India

Submitted to
Prof. R. Ramaseshan

Submitted by
SUMIT TIWARI (P43245)

CONTENT TABLE

Page 1 of 12
SERIAL NUMBER TOPIC PAGE NUMBER

ALGO TRADING - 3
1 INTRODUCTION

HISTORY 3
2

HOW IT WORKS 4
3

ADVANTAGES 5
4

DISADVANTAGES 6
5

ALGO TRADING 8
6 STRATEGIES

MARKET OF ALGO 8
7 TRADING

TREND IN ALGO 10
8 TRADING

REGULATION IN INDIA 11
9

CONCLUSION 11
10

REFRENCES 12
11

Algo trading- concepts, trends, and the regulatory

environment in India

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Many names like automated and black-box trading know Algo trading as synonyms for
algorithmic trading. Using computer algorithms to make trading decisions in financial
markets is called algorithmic trading. Pre-defined rules and mathematical models
automatically place orders, generate trading signals, and analyse market data without human
intervention. It helps investors and traders to execute trades quickly and accurately to
increase profits. Algo trading makes the market more liquid due to the lack of human
emotion.

History
The financial markets began to be computerised in the early 1970s when the NYSE
introduced DOT (“designated order turnaround”). After some time, in 1984, the super dot
was introduced, an upgraded version of DOT. These versions improved efficiency by sending
orders for listed securities through a trading floor specialist rather than a broker. In the late
1980s and early 1990s, financial markets with entirely electronic execution and comparable
electronic communication networks emerged. It's possible that decimalisation, which changed
the minimum tick size in the United States from 1/16 of a dollar (US$0.0625) to US$0.01 per
share and altered the market microstructure by allowing more minor differences between bid
and offer prices, decreasing the trading advantage held by market makers, and thus increasing
market liquidity, encouraged algorithmic trading.
Electronic exchanges were permitted by the Securities and Exchange Commission (SEC) of
the United States up until 1998, paving the way for computerised high-frequency trading.
HFT had the option to execute exchanges multiple times quicker than a human. High-
frequency trading, or HFT, has also spread since then.
HFT trades had an execution time of several seconds by the year 2001. This had decreased to
milliseconds by 2010 and even to microseconds and nanoseconds in 2012. High-frequency
trading accounted for less than 10% of equity orders at the beginning of the 2000s, but this
has increased rapidly. According to the NYSE, high-frequency trading volume increased by
164% between 2005 and 2009. In 2011 Fixnetix released a microchip that can do trading in
nanoseconds.
In 2008 SEBI legalised the use of algo trading in India.

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 How it works:
Creation of a Strategy: Based on a variety of factors, such as fundamental analysis,
statistical models, technical indicators, or news sentiment analysis, traders or quantitative
analysts creates trading strategies. The procedures for entering and exiting trades are outlined
in these strategies.
Implementation of the Algorithm: A computer algorithm must be used to implement a
strategy once it has been developed. The algorithms are typically coded in proprietary trading
platforms or programming languages like Python and C++.
Collection of Data: Algorithm traders collect pertinent market information, such as price,
volume, order book, news feeds, and social media sentiment. Analysing and making informed
trading decisions require this data.
Market Research: The algorithm examines the collected data using the specified strategy.
Using various mathematical and statistical methods, it might look for market trends, patterns,
or anomalies.
Generation of Signals: Given the examination, the calculation produces exchanging signals,
which show whether to purchase, sell, or hold a specific monetary instrument. Predefined
conditions or thresholds the trader sets typically serve as the foundation for these signals.
Placing an Order: When an exchanging signal is created, the calculation naturally sends
requests to the market, determining the instrument, amount, and cost. This can be
accomplished through broker APIs or direct connections to exchanges.
Execution of Trades: The algorithm's orders are carried out in the market. In algo trading,
speed of execution is crucial because even a minute delay can affect the desired price or
cause opportunities to be missed.
Management of risk: Risk management features are frequently included in algo trading
systems to limit losses. These are examples of stop-loss orders, limit positions, and risk-
reward ratios.
Monitoring the Performance: Algorithm trading strategies are closely watched by traders.
To determine the algorithms ' efficacy, they look at relevant statistics like profitability,
win/loss ratio, and drawdowns.

Advantages
The use of computer algorithms to automate the process of trading financial instruments is
called algorithmic trading or algo trading. Algorithm trading has several advantages:
Consistency and Accuracy: The possibility of human errors brought on by emotional or
impulsive decision-making is eliminated by algorithm trading. Algorithms ensure consistency

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and accuracy in trading by executing trades based on objective criteria and adhering to
predefined rules.
Cost savings for transactions: By optimising order placement and execution, algorithmic
trading can reduce transaction costs. Using liquidity and minimising market impact,
algorithms can split large orders into smaller ones and execute them at appropriate times.
Efficiency and rapidity: Algorithm trading executes trades with low latency and extremely
high speeds. Compared to manual trading, it allows for faster order placement, routing, and
trade execution, which can be crucial in markets where timing is critical.
Management of risk: Algorithm trading systems can help safeguard against significant
losses by incorporating risk management strategies and predetermined stop-loss levels. The
calculation can naturally carry out these gamble controls, diminishing the dependence on
human mediation.
Enhanced Opportunities for Trading: Trading opportunities across multiple instruments
and markets can be identified simultaneously by analysing large amounts of market data by
algorithms. This makes it possible to investigate a broader range of strategies and find
profitable trades that human traders might miss.
Trading without a feeling: Algorithmic trading helps eliminate biases like fear and greed,
which can hurt decision-making, by removing human emotions from the trading process.
Trading decisions that are more rational and disciplined may result from this.
Optimisation and backtesting: Using historical data, algo trading systems can be back-
tested to determine their profitability and performance. Before putting their strategies into
action in real-time trading, traders can use this to fine-tune and improve them, increasing
their chances of success.
Market surveillance: Market conditions can be continuously monitored by algorithmic
trading systems, allowing them to respond immediately to changes. This ensures that trading
risks or opportunities are found quickly and taken care of immediately.
Increased Volumes of Trade: Large trade volumes that might be difficult for manual traders
to manage can be managed by algo trading. It allows trading operations scalability and
efficiency by executing multiple trades simultaneously.
Time commitment reduced: With minimal human intervention, algo trading can operate
independently, freeing up traders' time for other activities. Instead of wasting too much time
on manual trade execution, traders can concentrate on developing strategies, monitoring
performance, and exploring novel trading concepts.
It is essential to remember that although algo trading has several benefits, it also comes with
risks and necessitates careful development, testing, and monitoring to perform at its best.

Disadvantages:
Algorithm trading has several benefits, but it also has a few drawbacks and dangers:
Errors in the technology: Technology failures, such as connectivity issues, hardware
malfunctions, or software glitches, are common in algorithm trading. These failures may

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result in issues with trade execution, delays, or erroneous trades that may cause financial
losses.
Over-Optimization: Overfitting, in which the algorithm becomes overly tailored to past
market conditions, can occur when trading algorithms are optimised using historical data. As
a result, trading results may need improvement because the algorithm may need to perform
better in different market environments.
The incapability of Adapting: Algo trading systems operate by predetermined rules and
strategies. They might be unable to quickly adjust to sudden shifts in the market, news, or
other circumstances that call for human judgment and decision-making. This rigidity may
result in missed opportunities or losses during market volatility or unpredictability.
Dependence on Data: Algorithm trading relies on timely and accurate market data. The
algorithms' performance and dependability may suffer because of data feed delays or errors.
Conversely, algorithms may be sensitive to changes in data formats or sources, necessitating
constant monitoring and adjusting.
Legal and Regulatory Dangers: Compliance with relevant laws and regulations is essential
because algorithm trading is subject to regulatory oversight. Penalties, fines, or legal action
may be taken if regulations are not followed. Additionally, concerns about market
manipulation, spoofing, or disruptive trading practices can be raised by rapid and automated
trading, drawing regulatory attention.
Market Dangers: Algorithm trading is still susceptible to market risks, even though it can
mitigate some risks. Market conditions like sudden price changes, a lack of liquidity, or
extreme volatility can affect algorithmic trading strategies, resulting in unanticipated losses.
These risks must be carefully monitored and managed by algo traders.
Maintenance and Development of Complexity: Resources, financial knowledge, and
technical expertise are required to construct and maintain a robust and efficient algorithm
trading system. It involves data management, continuous monitoring, and intricate
programming. Much money can be spent on development, infrastructure, data feeds, and
ongoing maintenance.
Dependence on Data from the Past: Backtesting and optimisation is done with historical
data in algo trading. However, historical data may only sometimes accurately represent
current market conditions. Historical data can become less relevant because of changes in
market dynamics, regulations, or economic factors, resulting in poor trading decisions.
Loss of Human Reasonability: The fact that algo trading removes the need for human
judgment from making decisions can have both positive and negative effects. While
removing biases and emotions can be helpful, relying entirely on algorithms can lead to
missed opportunities or an inability to adapt to unique circumstances that necessitate human
judgment and insight.
Algorithm traders must be aware of these drawbacks and effectively manage them through
risk management strategies, ongoing monitoring, and regular system evaluations.
Enhanced Opportunities for Trading: Trading opportunities across multiple instruments
and markets can be identified simultaneously by analysing large amounts of market data by

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algorithms. This makes it possible to investigate a broader range of strategies and find
profitable trades that human traders might miss.
Management of risk: Algorithm trading systems can help safeguard against significant
losses by incorporating risk management strategies and predetermined stop-loss levels. The
calculation can naturally carry out these gamble controls, diminishing the dependence on
human mediation.
Optimisation and backtesting: Using historical data, algo trading systems can be back-
tested to determine their profitability and performance. Before putting their strategies into
action in real-time trading, traders can use this to fine-tune and improve them, increasing
their chances of success.
Trading without a feeling: Algorithmic trading helps eliminate biases like fear and greed,
which can hurt decision-making, by removing human emotions from the trading process.
Trading decisions that are more rational and disciplined may result from this.
Increased Volumes of Trade: Large trade volumes that might be difficult for manual traders
to manage can be managed by algo trading. It allows trading operations scalability and
efficiency by executing multiple trades simultaneously.
Market surveillance: Market conditions can be continuously monitored by algorithmic
trading systems, allowing them to respond immediately to changes. This ensures that trading
risks or opportunities are found quickly and taken care of immediately.
Time commitment reduced: With minimal human intervention, algo trading can operate
independently, freeing up traders' time for other activities. Instead of wasting too much time
on manual trade execution, traders can concentrate on developing strategies, monitoring
performance, and exploring novel trading concepts.
It is essential to remember that although algo trading has several benefits, it also comes with
risks and necessitates careful development, testing, and monitoring to perform at its best.

Algo- trading strategies

To make well-informed trading decisions, traders employ a variety of approaches and
methods when it comes to algorithmic trading strategies. Some well-liked algorithmic trading
strategies are as follows:
Trend following: Trading in the direction of current market trends is part of this strategy.
Traders use indicators and patterns from technical analysis to identify upward or downward
trends and carry out trades accordingly.
Mean Reversion: After deviating from the mean or average value, this strategy assumes that
prices will eventually return to them. In the hope that the price will return to the mean, traders
take positions when conditions are overbought or oversold.

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Breakout: Trading price breakouts from clearly defined levels of support or resistance is the
primary focus of this strategy. In anticipation of a significant price change, traders monitor
price consolidation patterns and open positions when the price breaks out of these ranges.
Arbitrage: Utilizing price differences between two or more markets or exchanges for the
same asset is known as "arbitrage." Traders carry out simultaneous trades to profit without
taking risks and take advantage of brief price differences.
Statistical arbitrage: This strategy includes identifying statistical relationships or
correlations between multiple assets. Based on these relationships, traders construct portfolios
with long and short positions to profit from price convergence or divergence.
Trading with high frequency (HFT): To execute many trades in a short amount of time,
HFT strategies make use of powerful computers and cutting-edge algorithms. Minor price
differences and fleeting market inefficiencies are the focus of these strategies.
Trading based on the news: Market movements are predicted by traders using this strategy,
who rely on news announcements, economic indicators, and corporate events. Automated
systems scan news sources, analyse sentiment, and make trades based on the results.
Quantitative Methodologies: Quantitative trading strategies use statistical and mathematical
models to find trading opportunities. These models ordinarily consolidate different
information inputs, like verifiable cost information, volume, unpredictability, and other
pertinent elements.
Developing and implementing algorithmic trading strategies necessitates a thorough
knowledge of the financial markets, proficiency in programming, and access to reliable
market data. Risk management and rigorous back-testing methods should also be used to
evaluate and improve these strategies' performance.

The market of algo trading

The market size in algorithm trading is expected to grow by a CAGR of 8.53. It will
grow from USD 15.7 billion in 2023 to USD 23.74 billion by 2028.
Favourable governmental regulations, rising demand for order execution that is quick,
dependable, and efficient, rising demand for market surveillance, and decreasing transaction
costs are expected to drive the need for the algorithmic trading industry. Algorithmic trading
is used by large brokerage houses and institutional investors to cut costs associated with bulk
trading. Algorithms for financial services and artificial intelligence (AI) will produce
appealing opportunities for market expansion. The algorithmic trading market is expected to
expand in tandem with cloud-based solutions. Algorithmic trading has dominated the capital
markets, and FinTech tools have been developed to enhance the capabilities of the financial
sector.
The financial services sector's widespread adoption of AI, machine learning, and big data is
anticipated to significantly impact the algorithmic trading market's expansion. Because buy
and sell orders are placed quickly without human intervention, algorithmic trading can
maintain exceptionally high market liquidity. According to TRADE's January 2022

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Algorithmic Trading Survey, more and more hedge funds are trading their portfolios using
algorithms. The three algorithms used the most were implementation insufficiency, VWAP,
and dark liquidity seeking. Increased trader productivity, decreased market impact,
consistency in execution performance, ease of use, and low commission rates are the primary
motivations behind using the algorithms.
In addition, market volatility has increased the demand for algorithmic trading services and
products. Due to the need for quick digital transformation to deal with remote working
environments, large trading volumes, and volatile market conditions, algorithmic trading has
grown. The pandemic boosted the rate of expansion of the algorithmic trading industry.

Trends in algorithm trading

Machine Learning and Artificial Intelligence
In algorithmic trading, AI and machine learning techniques are on the rise. These
technologies make predictions, identify patterns, and analyse data to help make trading
decisions. Trading strategies are being improved using neural networks, deep learning
models, and reinforcement learning algorithms.
Alternative Data:
Traders are increasingly exploring alternative data sources beyond traditional market data to
gain a competitive edge. Alternative data refers to non-traditional data sets such as social
media sentiment, satellite imagery, web scraping data, etc. It generates unique insights and
identifies trading opportunities that conventional data sources may not capture.

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High-Frequency Trading:
HFT companies keep improving their infrastructure and strategies. To execute trades at
incredibly high speeds, they utilise cutting-edge technologies like low-latency trading
systems, colocation services, and optimised network connectivity. Worldwide, HFT
companies are also expanding into new asset classes and markets.
Regulation and compliance:
The regulatory environment for algorithmic trading is changing, with an increased emphasis
on market integrity, transparency, and risk management. Regulatory bodies enforce stricter
rules and guidelines to ensure that markets are fair and orderly. Market participants are
improving their compliance frameworks and monitoring systems to adapt to these
regulations.
Smart Order Routing:
To improve trade execution, execution algorithms and smart order routing systems continue
to develop. To achieve the best possible execution outcomes, these algorithms intelligently
route orders to various exchanges or venues based on liquidity, price, and market impact.
Instruments and Platforms for Quantitative Research:
There has been an increase in the number of sophisticated quantitative research platforms and
tools available. Backtesting, optimisation, data analysis, and strategy creation can all be done
in one place on these platforms. They make it simple for researchers and traders to prototype
and test trading concepts quickly.
Added Attention to Risk Management:
In algorithmic trading, risk management is given more importance. Market participants invest
in robust risk management systems and methods to reduce the risks of complex trading
algorithms and high-frequency trading.
It is essential to remember that the algorithmic trading field is ever-evolving, and brand-new
developments and trends continue to emerge. As a result, if you want to stay at the forefront
of algorithm trading practices, it's best to keep up with the most recent news, research, and
industry developments.

The regulatory environment in India

Algo trading in India was legalised in the year 2008 by SEBI.
The Securities and Exchange Board of India (SEBI), India's primary securities market
regulator, oversees algorithmic trading. SEBI has executed explicit guidelines and rules to
administer algorithmic exchange exercises. The following are some essential rules for algo
trading in India:
Framework for Algorithmic Trading: India's algorithmic trading framework has been
developed by SEBI. The framework's requirements cover organisations involved in
algorithmic trading for infrastructure, risk management, testing, and monitoring.

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Validation and Registration: Stockbrokers, for example, must register as "stockbrokers
providing algo trading" with SEBI to engage in algorithmic trading. They must adhere to the
required eligibility requirements and regulatory obligations.
Systems and controls for risk: Entities that engage in algorithmic trading are required by
SEBI to have robust risk control systems and mechanisms in place. Pre-trade risk checks,
order flow controls, circuit breakers, and safeguards against erroneous orders and
manipulative behaviour are all included in this.

Co-location facilities: Co-location facilities, which allow market participants to locate their
servers close to the trading infrastructure of the stock exchange, are governed by SEBI. Fair
access to co-location facilities and the prevention of unfair advantages are the goals of these
guidelines.
Method for Approving the Algorithm: SEBI requires entities to obtain approval before
deploying their algorithms for live trading. The endorsement interaction includes submitting
itemised data about the calculation's rationale, boundaries, the risk to the executives, and
consistency measures.
Audit and Monitoring: SEBI regularly conducts inspections and audits to guarantee that
businesses engaged in algorithmic trading abide by all applicable regulations. They also have
surveillance systems to monitor algorithmic trading activities and catch any possible market
manipulation or abuse.
It is essential to remember that rules and guidelines may change over time. To ensure that
you adhere to the most current requirements for algorithmic trading in India, you should
check the most recent updates from SEBI or talk to professionals in law and compliance.
Conclusion
In India, the popularity of algorithm trading is rising day by day since Sebi has regularised
algorithm trading. In India, algorithm trading will increase in the years to come. India's
current penetration of 50 to 60% algorithm trading market is expected to increase with a
CAGR of 11.23% between 2021 to 2026. Also, it is expected to contribute $8.61 billion to
the algorithm market share in 2027. (quantinsti.com)

References:
https://www.investopedia.com/articles/active-trading/101014/basics-algorithmic-trading-
concepts-and-examples.asp#:~:text=Algorithmic%20trading%20(also%20called
%20automated,impossible%20for%20a%20human%20trader.
https://www.indmoney.com/articles/stocks/what-is-algorithmic-trading
https://blog.quantinsti.com/algorithmic-trading-india/
WIKIPEDIA
Groww YouTube channel

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