Algorithmic Trading in National Stock Exchange (NSE)
The National Stock Exchange (NSE) data reveals a dominant presence of algorithmic trading (algo trading) across all trading segments. Even in the cash equity segment, primarily run by individual traders, algorithms accounted for approximately 54% of trades by value as of February 2023.
Growth and Impact
- 1. Derivatives Dominance: In other segments such as derivatives, including equity, commodity, currency, and interest rates, algorithms have been leading for over a decade.
- 2. Regulatory Support: The regulator's approval for offering algo-trading tools to retail investors is expected to accelerate the adoption of algorithmic trading.
- 3. Global Trends: This shift aligns NSE with global exchanges where most trades are machine-executed with minimal human involvement.
Mechanics of Algorithmic Trading
- 1. Pattern Recognition: Traders (human or otherwise) identify statistical and mathematical patterns in historical trading data and news.
- 2. Pre-programmed Rules: Trades are initiated based on strict rules to respond to these patterns, ensuring disciplined trading.
- 3. Fail-safes and Money Management: Algorithms include mechanisms like stop-losses and parameters for managing trades and impact costs.
Historical Context
Algorithmic trading gained traction from the 1980s, with the Black Monday crash of October 19, 1987, emphasizing the need for circuit breakers and human oversight due to the role of unsupervised algorithms in the crash.
Current Landscape
- 1. Advanced Technology: The integration of artificial intelligence and neural networks has made algorithms more complex and less comprehensible to humans.
- 2. Market Influence: Algorithms now control arbitrages of minor price differences and responses to news, overshadowing manual traders.
- 3. Cash Market Shift: Even in the cash market, known for less leverage and time sensitivity, algorithms are gaining an advantage.
- 4. Impact on Traders: Manual day-traders are likely to become obsolete, with only long-term investors retaining a manual "buy and hold" approach.