In India, approximately one-third of all trades placed online are through HFT- otherwise known as High-Frequency Trading. These trades are placed through algorithms written by programmers and done through algorithmic trading.
A brief history of algorithmic trading (HFT) in India.
In late 2008, SEBI allowed for “Direct Market Access” – that is, DMA, to be opened up in India. This allowed high-frequency trading to be granted access to all the leading exchanges in India.
HFT and algorithmic trading can be thought of as one and the same. The advantage of an HFT trade is that, because it is coded through an algorithm, its signal generation for buys and sells is done automatically. Once a buy signal is generated by an algorithm, the trade is executed within fractions of a second. This gives a huge advantage to algorithmic traders. In fact, trades are executed in milliseconds; a screen-based trader takes seconds to react to a price change on his terminal and place a trade.
How are algorithms designed?
Algorithmic traders usually use historical data to design and develop their algorithms. They use a system called backtesting which tests the profitability of the strategy on historical data. Algorithms are developed by observing patterns in the market. The premise is that a pattern from the past will continue in the future.
Risk management is critical with algorithmic trading. That is why, for any HFT algorithm to be approved by the markets, exchanges require a firm to undergo a series of stringent tests if it intends to trade through HFT. These tests include the number of orders that would be placed per second, the maximum order value of any order placed, and the maximum traded quantity during a particular trading day.
There is a lot of scrutiny surrounding algorithmic trading, not only in India but around the world across all major Stock Exchanges. That being said, it’s a safe bet to say that HFT is here to stay in India.