July 25, 2016
algo trading, direct market access trading analysis
Algo trading in check, DMA (direct market access) trading goes up on the NSE.
The regulatory scanner in recent months has managed to keep algorithmic (algo) trading under check as is indicated from the flat growth in its share of total turnover on the National Stock Exchange. This is seen in an analysis done by us on the share of different modes of trading on NSE's cash market and equity derivatives segment (see chart). In the last six months, from end of last year to the end of June this year, algo trades's share of gross turnover has come down marginally from 17.8 per cent to 17.5 per cent in the cash market and from 4.2 per cent to 4.1 per cent in the equity derivatives segment.
Notable changes are, however, seen in the share of direct market access (DMA) mode of trading on NSE's equity derivatives segment. It has gone up from 4.0 per cent at the end of last year to 6.6 per cent currently. This mode of trading which is used only by the institutional investors who are allowed to log in to the stock exchange's trading system through trading terminals in their offices rather than route it through their brokers trading terminals. The trades, however, still go under the name of a broker or a clearing member.
Around a year ago, in September 2015, the share of DMA on NSE's equity derivatives segment was further lower at 3.7 per cent. DMA share is not significant on the cash market of NSE, however, where it is just 0.6 per cent currently and which has not changed since six months ago.
Trades under the co-location facility offered by stock exchanges to their member-brokers, have also seen a rise, with the share in total turnover going up from 32.1 per cent to 34.9 per cent on the equity derivatives segment and from 21.4 per cent to 22.9 per cent in the cash market. Internet-based, and mobile-based, trading's share has been steadily going up over the last few years and in the last six months as well.
In the equity derivatives segment, internet-based trading's share rose from 13.1 per cent to 13.8 per cent, while mobile-based trading's share went up from 1.2 per cent to 1.6 per cent. In the cash market, internet trading's share increased from 11.8 per cent to 12.3 per cent, but the rise in mobile trading's share was much higher from 2.5 per cent to 3.2 per cent.
Although DMA and co-location facility has seen its fair share of concerns among retail investors, regulatory attention has been mostly focussed on algo trading. Algo trading, or high frequency trading, are essentially pre-programmed technical trading strategies which exploit live market prices and technical trends emerging from it.
The strategies can be highly diverse encompassing momentum trading strategy, cash-futures arbitrage, cross-market pricing inefficiencies and many more. In the developed markets such as the US equity markets, algo trading accounts for half or more of the total turnover.
In the domestic equity markets on NSE and BSE, and as per the norms of Securities and Exchange Board of India (Sebi), algo trading carries higher restrictions than in international markets. Any brokerage firm who wishes to apply algos on trades done by it or any of its clients have to disclose the strategies to the exchanges.
The exchanges have to scrutinise the strategies in order to ensure there are no potentially market-disruptive ones, and only then the brokerage firm's software programs are allowed to reside in the brokers' trading system to execute algo trades in the split of a second. A couple of months back, a Sebi technical committee was reported to be examining concerns on algo trading and had sought details regarding the same from the NSE.