Understanding Algorithmic Trading
Algorithmic trading refers to a computer generated buy/sell trade orders using pre-defined conditions. In India, the words- algo, auto, algorithmic and automatic are used interchangeably and imply the same thing. ATS, acronym for Automated Trading System, refers to the set of applications used for auto trading
Difference between Algorithmic Trading, Automated Trading, Algo Trading
Algorithmic Trading refers to execution side of a trade- how an order may be sent to market and automatically modified to fetch the best price. In algo trading, the buy/sell decisions are not taken by the computer- the computer automates the execution part only.
Automated Trading refers to completely automatic trading, where even the buy/sell decisions are taken by the computer. A very common example is the use of Charting Strategy for generating buy/sell signals and using broker provided in-house CTCL to push orders automatically to the exchange.
Algo Trading is an informal term which indicates trading with a set of rules, whether or not automated. In common usage, it may mean rule-based generation of signals only.
Other ambiguous terms:
Strategy Trading: refers to trading using a set of -pre-defined buy/sell rules, with or without using an ATS
Systematic Trading: refers to set of pre-defined buy/sell, money management and execution rules
Quantitative Trading (Black Box): refers to trading using a set of complicated mathematical models
High Frequency Trading (HFT): refers to very-short term trading or sending a very large number of trade orders within second. HFT systems are intrinsically latency sensitive and HFT strategies compete with each other in microseconds.
Statistical Arbitrage(StatArb): refers to arbitrage trading using statistical models
Ok, Any Basic Examples?
Main article: Conditional Orders: Algo for Discretionary Traders
Say a trader decides that every time he buys a stock, he will either sell it in Rs. 5000 profit or Rs. 2000 loss. The trader may punch only the buy order, while the sell order may be automatically punched by his computer because Sell conditions are pre-defined. The initial trade is taken discretionally by the trader, but the computer automatically exits the position depending upon the profit or loss from the market.
This logic can be automated through Bracket Order- an algo trading product offered free by most brokers.
Suppose you buy DLF firstname.lastname@example.org and want to sell when prices rise to 350 Rs. The prices may rise to the level of 350 tomorrow, next week or next month- so basically you want your Sell order to remain in market as long as it is not filled. Since all buy/sell orders in NSE expire at current day session, you can instruct your computer to place a fresh order SELL DLF @ 350 every day morning when market opens. Thus the algo may emulate the GTC (Good-Till-Cancel) order facility.
Please note that ATS generates buy/sell signals essentially by applying conditions on market prices.
Automated Trading” shall mean and include any software or facility by the use of which, upon the fulfillment of certain specified parameters, without the necessity of manual entry of orders, buy/sell orders are automatically generated and pushed into the trading system of the Exchange for the purpose of matching. SEBI has allowed Exchanges to extend Algorithmic trading facility to members involving usage of various Decision Support Tools / algorithms / strategies
Consolidated Circular on Algo Trading, mentions the guidelines and approval check list dated September 28, 2012. Read here
Circular regarding checklist in derivative segment, dated October 23, 2012.Read here
Circular regarding checklist in FnO segment, dated October 23, 2012.Read here
Circular regarding checklist in Capital Market segment, dated October 23, 2012.Read here
SEBI Circulars on Algo Trading
Broad Guidelines on Algorithmic Trading, dated September 2016. Read here
Broad Guidelines on Algorithmic Trading, dated May 21, 2013. Read here
Broad Guidelines on Algorithmic Trading, dated March 30, 2012. Read here