RBI report cautions against surge in algo trading

The Reserve Bank has warned against the rising popularity of superfast algorithm trading, saying its complex coding and ultra-low latency due to its advanced communication platforms increase risks of erroneous trades and manipulations in stock markets.
"The increased complexities of algorithm coding and reduction in latency due to faster communication platforms need focused monitoring as they may pose risks in the form of increased possibilities of error trades and market manipulation," said Financial Stability Report released by RBI late last week.
FSR says the volumes in algo trading and high frequency trading (HFT) have increased substantially over the past few years in the cash segment from 17 per cent on NSE and 11 per cent on BSE in 2011, respectively, to around 40 per cent of total trades in both the exchanges by March 2015.

Algorithm (algo) trading refers to the use of electronic platforms for entering trading orders with a computer programme (algorithm) determining the decisions on aspects such as the timing, price, or quantity of the order or in many cases initiating the order without human intervention.
Algo trading is subject to Sebi regulations issued in March 2012 and May 2013.
The market watchdog Sebi allowed introduction of algo trading in April 2008 with the introduction of direct market access, a facility that allows clients to directly access a broker's trading infrastructure, linked to the exchange trading system, without any manual intervention by brokers.

Reduced latency with respect to trading refers to network connections used by financial intermediaries to connect to exchanges and electronic communication networks to execute financial transactions at a very fast pace.

"The fact that the share of algo orders in total orders and the share of cancelled algo orders in the total number of cancelled orders is around 90 per cent creates concerns relating to systemic risks," the FSR report highlighted.
There have been certain instances of abnormal market movements which have been attributed, by market experts, to algo trading.
The increasing volume of algo trades and their attendant risks have forced regulators the world over to have a closer look at gaps in the existing regulations and explore ways of strengthening them, FSR said.