The date is out. From 1st August 2025, retail investors will be trading through algo. The capital market regulator SEBI has been generous enough to facilitate this. The retail investors are feeling charged as if algo is a genie to fulfil all their trading wishes. The fact remains that retailors have been permitted algo trading to benefit brokers, exchanges and the fintech companies. It is a compensation package for their forgone revenues due to F&O clampdown. Retail investors may feel cheated once they analyze their contract notes. Let us examine this in detail.
What is Algo trading: Algo trading is an automated trading system. In normal circumstances either you place buy/sell orders yourself or through your dealer/relationship manager. In algo trading, buy/sell orders are placed by the system itself. For example, a share XYZ is trading at Rs 200 at BSE and the same share is trading at Rs 200.50 at NSE. You can buy the share at BSE and sell at NSE. Through this trade you will pocket 50 paisa in each trade. This trade involves three legs. One, identifying a share which is trading at different rates at BSE/NSE at a given time. Finding the share with maximum price differential is the key to success. Two, taking BUY trade at lower price and SELL trade at higher price. Three, taking trade at a faster speed because more the number of trades, higher the profit. A computer program can be written in a way which will identify shares with highest differential, initiate trades and generate profit. This computer program will be named as an Algorithm (Algo). This is a simple Algo based on arbitrage. Cash to cash, Cash to derivative, derivative to derivative arbitrage are examples of simple Algo.
Types of Algo: Algo are of two types: White Box Algo and Black Box Algo. As the name suggests, White Box Algo is a transparent algo system, wherein user has access to the logic, decision making and execution of the Algo system. This is also called Execution Algo. In aforesaid example, we discussed the logic, its outcome and execution of cash segment inter-exchange arbitrage. An Algo system based on this logic will be called White Box Algo. On the other hand, a Black Box Algo is fully opaque. You only know the outcome. You don’t have access to the logic, rationale and decision-making process of Algo system.
What has SEBI said? SEBI has allowed algo trading to investors through their brokers. The Algos will be back tested and approved by Exchanges. Brokers will be permitted to use such approved Algo. Each order placed through Algo trading API (Application Programming Interface) will be tagged with a unique identifier. API will be developed by fintech companies. These APIs will be approved by Exchanges and utilized by Brokers.
Who will benefit the most from Algo? Algo trading is a volume-based business. You buy and sell numerous times at a faster speed to accumulate small profits. (remember the adage, small drops make an ocean)Therefore, those stakeholders who gain from surge in trading volume will be the key beneficiaries. Brokers’ revenue will surge due to high volume of trade. Fintech companies will gain from developing and selling Algo APIs. Exchanges will earn from exponential surge in turn over. Brokers’ will further gain from turn over incentive. The government will gain from STT, CGST and SGST like taxes. Retail investors may lose or gain, but algo trading will certainly enrich the coffers of Brokers, Exchanges, Fintech Companies and the almighty Government.
Retail investors should understand the gimmick of algo trading. It is basically a mechanism designed to compensate brokers, exchanges, fintech and the government for the revenue lost due to regulatory clamp down on F&O.
