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5 July 2015

Algorithmic Trading Has Forever Skewed Luck In Favor

Of Those Who Have Access To It
HuffPost India | By Anirvan Ghosh
Posted: 07/06/2015 14:06 IST

Updated: 07/06/2015 14:47 IST

On May 5, the Indian benchmark Sensex and Nifty tanked, losing over 2 percent to wipe out entire gains made last year. The main reason:
algorithmic trading.
Such mishaps have happened before, despite SEBI tightening its rules for algo-trades, as traders call them. This form of high-speed trading
rose 12 percent on the Bombay Stock Exchange, to account for almost 30 percent of total trades. Its share is higher in the National Stock
Exchange, with nearly 46 percent of trades happening on the platform.
What exactly is algo trade? This is a form of high speed trading that Michael Lewis chronicled in his bestseller 'Flash Boys' in which
computers execute pre-programmed trade orders. It happens at tremendous speed, way quicker than what human traders are capable of,
and is much more efficient. However, that can also result in large trades that can swing the market and result in significant losses for
ordinary investors, like what happened on May 6. Most investors don't stand a chance of trading in stocks that are being traded
All major brokers now have options for algo trading. This has also spawned start-ups that hire engineers to offer similar trading facilities as
the bigger guys. HuffPost spoke with with Kunal Nandwani, CEO & Founder, uTrade Solutions, a financial trading technology company that
is engaged in algorithmic trading, about high speed trading, pitfalls in this kind of trading, and how small traders got priced out. Nandwani,
who previously worked with Lehman Brothers, Nomura and BNP Paribas in London, raised $800,000 in seed funding for the firm that now
employs 40 people and has 15 financial institutional clients.
1. What is algorithmic trading? How is it different from human traders executing orders?
Simply put, Algorithmic trading is a system of trading which facilitates transaction decision making in the financial markets using any
simple or complex logics, based on user certain inputs. Guidelines of the Securities Exchange Board of India (SEBI) define algorithmic
trading, popularly called algo trading in trading parlance, as any order that is generated using automated execution logic in which the
computer executes the pre-programmed trading instructions, accounting for a variety of variables such as timing, price and volume. It offers
the benefits of speedier and more efficient order execution when compared to human traders executing orders, also mitigating execution
cost as well as the scope for any manual errors and emotional trading decisions.
2. On May 6, four large orders in Nifty May futures, ranging between 7,000 and 39,000 contracts, were traded between
9:41am and 9:53am. The deals were worth Rs 1,470 crore and the stock market crashed wiping out all gains made the
year before. All of these were algorithmic. Can you explain what might have happened?
As I understand, a large part of above trading volume can be adduced to foreign institutional investors (FIIs) reducing their exposure to
Indian markets as a part of their plan to re-allocate funds in the subsequent week to the Chinese markets for IPOs of around 20 companies
amounting to $483.19 billion, intensifying outflows from countries such as India. On the back of weak corporate earnings and uncertainty
over certain taxation issues, FIIs chose to re-allocate their funds which is not unusual.
The execution of their sell orders were indeed through algorithms (for example, Time Weighted Average Price algorithms which slice the

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Algorithmic Trading Has Forever Skewed Luck In Favor Of Those Who...

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larger parent order into smaller child orders executed every few minutes in the market) causing the Sensex to tumble by 723 points. What
has to be underscored is the point that this fall wasnt the consequence of any dysfunctional algorithm and hence not an aberration. Had the
trades been executed manually, they would have still had the same impact albeit the time taken would have been much longer to sell the
positions. Algorithms did what they were designed to do, which was to ensure efficient sell order execution.
3. Is it the same as high-frequency trading involving 'dark pools'? This subject was covered by Michael Lewis covered in
his book 'Flash Boys'.
High Frequency Trading (HFT) are algorithmic trades which entail very fast execution, typically more than 100 orders per second on
average, with an objective of making small profits on minor market movements by buying and selling small or large volumes of security
Dark Pools are a means of off-exchange trading which facilitate block trading for institutional investors and are designed not to impact the
market price with their large orders, leading to them realizing a more favorable price. Trade execution details are released after a time lag.
For example, If London Stock Exchange has best bid offer price on a stock as GBP 100-101, the dark pool like CHIX of Bats will cross the
same stock at GBP 100.5 but never show what orders are available in the market. This way fund manager can place large orders in a dark
pool, knowing that nobody will know about them, and they will get execution at mid of bid and ask.
4. So how is algo-trading different?
HFT is a subset of Algo trading. The difference largely as mentioned above is that when HFT is done involving dark pools, it constitutes an
off-exchange trade wherein order book data is not displayed to market participants. Whats common is only the usage of cutting edge
technology, used to make trading decisions.

"This costs between

Rs. 7.5-15.0 lakh per
annum, which most of
the small brokers find

5. Right now this form of trading is more expensive or so is the perception. What do you

Yes, the perception is right. You have to pay more for co-location. Through this, brokers are allowed to
place their servers within close proximity to an exchanges trading engine, giving them faster access to
price feed streamed from the exchange. This costs between Rs. 7.5-15.0 lakh per annum, which most of
the small brokers find unaffordable. The benefit derived is low-latency i.e. time required for data flow
between the exchange and the brokers trading system being minimized. The end result is that traders
get market information a few milliseconds beforehand which gives them an opportunity to capitalize upon to make profits.
6. As a company, how big do you think is the algorithmic trading market that you can address right now? How big might
it be, realistically, in the next five years?
Backed largely by institutional investors, algo trading constitute 46% of the total volume on the National Stock Exchange (NSE) and over
30% on the Bombay Stock Exchange (BSE). We are still way behind markets in the US and Europe in which Algo trades constitute 75-80%
and nearly 60% of the total trading volumes respectively. If Indian markets stay fundamentally strong to attract global capital over the next
five years, we can see the proportion of algo trades equaling that of the US in the next five years.
7. Many people are not aware about the existence of this form of trading. What has been the response that you got when
you set up your company? What is the response now?
Obsolescence, thanks to legacy systems, is what characterizes market trading platforms here in India. The retail trading community in India
is guided by the principle of profitability. With awareness of platforms that would leverage the benefits of superior technology and data
analytics to enable them to make better trading decisions, leading to greater profitability, we are optimistic that algo trading would see
greater adoption. Given that it requires quantitative as well as technical acumen, at present its appetite is restricted to a niche segment of
retail investors comprising IITians and other techies. Largely, proprietary traders, investment banks and financial institutions such as
brokerage firms constitute a major proportion of our user base. The very fact that we are facilitating over $10 billion worth of daily trades is
a vindication of the user adoption of our products from China to Chile.
8. Who are the core people you hire for this business and what are their main skills? Where do you hire from?
Being a fintech company that develops trading platforms which facilitate online trading for retail brokers, algo trading for prop traders and
institutional investors and data analytics, the skills we seek in our potential recruits include a strong domain knowledge of the functioning of
the financial markets along with software development skills. It is a combination of skills that is pretty rare to find. We hire from B-Schools
and Engineering schools which have such talent software engineers who go on to specialize in Finance.

9. How developed is the eco-system right now? Do you think Indian bourses will keep up
in pace with more developed financial markets in adopting technologies such as

"The main risk is the

algorithms can misfire
trades which were not
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Algorithmic Trading Has Forever Skewed Luck In Favor Of Those Who...


intended as part of the


high-speed trading?

The fintech space catering to the financial markets is highly fragmented and while you have many
established IT behemoths also in the fray, it is players who are fleet footed, innovative, technologically
superior and primed to cater to customer needs who would win market share. Indian bourses have grown fairly comprehensively over the
last two decades to feature in top 7 exchanges worldwide (in terms of number of trades done on an exchange). We believe that in order to
continue to attract global capital and stay competitive, they have to ramp up their technology. More than 80% of the Indian institutional
trading flow (from both FIIs and Domestic Fund Managers) goes through algorithmic execution currently. The National Stock Exchange
(NSE) has witnessed a 25% increase in active investors. While Retail participation stands at 2 crores (up 38% YoY), Institutional
participation surged to a new high of $310 billion in FY'15 (up 56% YoY) with 465 FIIs invested in Indian markets.
10. What are the pitfalls of algorithmic trading?
Algo trading, albeit its benefits of market making, greater liquidity, efficient price discovery and efficient order execution, comes with its
own share of risks. The main risk is the algorithms can misfire trades which were not intended as part of the logic. Hence, Algo traders need
to accord priority to risk management by mitigating and managing risk first, and then focusing on profits. To avoid market crashes, they
must observe sound Risk Management System (RMS) checks such as back testing algos against extreme events, kill switches (for cancelling
all trades when things go wrong), enforcing compliance and tracking patterns that may lead to systemic risks.
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MORE: Algorithmic Trading High Frequency Trading Michael Lewis Flash Boys Bombay Stock Exchange National Stock Exchange Business

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Saranathan Lakshminarasimhan Manager at Tube Investments of India Ltd.

sounds interesting
Like Reply Jun 7, 2015 1:01pm

Chinmay Jangid
You can't do anything.. It'll be a part of modern trading..HFT volume will
increase for sure in india.. no wonder
Like Reply Jun 20, 2015 12:52am
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