Algorithmic trading has now become the rage, officially. With 18% of trades in April being algorithmically generated, SEBI has now gotten more active in regulation. In guidelines released today, the regulator has mentioned that
- All algos need to be reviewed by system auditors every six months
- Stock exchanges need to specifically monitor orders from trading algorithms and ensure they can better detect manipulation and disruption.
Apart from these generic obligations, stock exchanges have been asked to double the fines for high order-to-trade ratios of algo clients. Most market making algorithms will place an order and modify or cancel the order very quickly to maintain a viable trade at any point (that is, for every order, there could be a corresponding other side like a future or a put-call-parity trade). In many cases, such unexecuted orders are huge in number while actual trades are low.
This is like a “missed call”, and puts stress on a trading system, but also hampers price discovery. If you see a bid and try to place an order to hit that bid, chances are that the algo keeps bumping the price around to see how low you will go, which is useless and frustrating for a regular trader.
Penalties for such high order-to-trade ratios on the NSE were between 1 and 5 paise per trade, if the order to trade ratio was above 50. (That is, 50 orders for every executed trade). Beyond 500, the algo trader was not allowed to place an order for the first 15 minutes of the next day.
Now, SEBI has doubled those fine amounts and also ordered a 1 hour lockout in case an algo trading broker is fined (any amount) for more than 10 out of the last 30 trading days. This additional penalty is to deter those who are willing to pay the penalty but will still persist with high order to trade ratios.
(The penalty is not high. For an algo generating 10 orders a second, the six hours of trading will generate about 225,000 orders, for which a 5 paise per order fine is just Rs. 11,250 a day – not a big amount for a broker!)
The new regulations will be in effect from Monday, May 27.
My view is that if this doesn’t deter behaviour then the system should impose a 5 second hold period per order for abusive clients. You get fined more than 10 days of the last 30, and your orders are held for 5 seconds in the market before they can be cancelled or modified. If this still results in abuse, double it to 10 seconds, 20 seconds and so on until they stop. Having seen the business closely, I believe this will reduce abuse substantially.
