With increasing demand for algo trading, the markets regulator has proposed reviewing the framework to strengthen the checks and balances in the system. While retail investors have been dabbling in algo, not many are aware of the complexities in this trading system dominated by institutional investors.
In algo trading, pre-defined computer programs execute multiple trades in milli-seconds. First of all, retail investors should only use algorithms approved by the stock exchange and set safeguards, such as stop-loss and exposure limits, to prevent significant losses. They should be wary of over-leveraging and monitor trades actively, even if they are automated.
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Kamlesh Gujar, chief compliance officer, Reliance Securities, says retail investors should begin by partnering with Sebi-registered brokers who offer algo trading services. “For tech-savvy individuals developing their own algorithms, it is crucial to test the strategy extensively and work with their broker to submit it for exchange approval. This ensures the algorithm complies with Sebi guidelines and exchange standards, making it safe for live trading,” he says.
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Registering an algorithm with the exchange involves compliance with tagging, audit trails, and other norms. Brokers provide secure API access and offer the necessary tools for algo testing and deployment.
Don’t be misled by back-testing results
Back-testing often paints an idealised picture of an algorithm’s performance based on historical data. Sonam Srivastava, founder, Wright Research, says retail investors should scrutinise assumptions such as perfect trade execution, no market impact, and low transaction costs, which may not hold in real-world conditions. “Investors should ask for details about the data used, methodology, and assumptions made during back-testing. It is advisable to test strategies in live market conditions with smaller capital before scaling up,” says Srivastava.
Safety measures
Investors need to understand the logic behind the algorithm and not blindly trust pre-built solutions. Staying updated with regulatory requirements and ensuring that the platform adheres to SEBI guidelines is key to safe algo trading.
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