RBI sounds a cautious note on algo trading

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The Reserve Bank of India (RBI) has cautioned against the growing use of high-frequency trading (HFT) and algorithmic (algo) trading technology in India. In its financial stability report released on Thursday, RBI said nearly a fifth of equity trades in the country was done using HFT or algo trading and the implications of these needed to be watched.

This is the first time a financial market regulator has revealed figures regarding the use of HFT or algo trading technology, which have been under a cloud globally. RBI has stressed the need to balance technological advancements with a pragmatic approach. “This assumes even more significance for India, as efforts are being made to increase retail participation in Indian securities markets to change the markets’ largely institutional character,” RBI said.

According to RBI, many recent instances of extreme volatility and disruptions witnessed by the Indian stock markets can be directly or indirectly attributed to the increasing use of HFT or algo trading. Globally, too, the balance between the benefits of such advancements vis-à-vis the risks posed by these is a subject of debate, said RBI.

Recently instances of a flash crash, where the trading price of security fell sharply in a few seconds, have gone up. Twice this year, stock trading on National Stock Exchange (NSE) was affected by such crash. During the first instance the share of the country's largest software exporting company Infosys fell 20 per cent in seconds. To make it worst, Infosys’ crash was followed by a seven per cent fall in the key benchmark index S&P CNX Nifty during within a couple of hours. Later, in a release issued the based on preliminary investigation, the exchange said that malfunction of algo trading was the reason for fall in Infosys shares if not the Nifty index.

If this was not enough, three weeks later trading on the NSE suffered for nearly an hour due to a ‘technical glitch’.

Orders did not match, as a price quote on the NSE showed the best buyer was offering a higher quote than seller wanted to sell. Experts were of the view that if an algo sends some junk or abnormal data, the exchange trading system may react differently and it may lead to disruption of order execution. All this happened when average trading volumes were around their low levels during the year. Also, the Bombay Stock Exchange had to annul all trades on ‘muhurat day’ in 2011 due to extraordinary volumes.

The Securities and Exchange Board of India had issued fresh guidelines for algo trading in March this year. To have appropriate risks control in place, Sebi has prescribed price filters and cap on trading quantity for such trades. It has also put a lot of onus on stock exchanges to ensure maintenance of orderly algo trading in the market.The HFT is a special class of algo trading, in which computers make elaborate decisions to initiate orders based on electronically accessed information, at a very fast speed (in microseconds), before human traders are capable of processing the information they observe.