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Concerns over risk in Algorithm trading: Explained

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The Financial Stability Report (FSR) June 2015, released by the Financial Stability and Development Council, which includes all financial market regulators, has raised concerns over the increasing clout of algorithm trading or high frequency trading (HFT).

What is Algorithm trading?

It is a trading system that utilizes very advanced mathematical models for making transaction decisions in the financial markets.

High-Frequency Trading is a subset of Algorithm trading. In HFT the focus is on transacting a large number of orders at very fast speeds.  Typically, the traders with the fastest execution speeds will be more profitable than traders with slower execution speeds.

Algo trading was introduced in India in April 2008 with the advent of direct market access (DMA).

The global debate on this issue was triggered by Michael Lewis’s best-selling book, Flash boys: A Wall Street Revolt, published in March last year, which discusses the rise of high frequency trading in U.S. equity markets and argues that the U.S. equity markets are rigged by the HFT traders.

Problems with Algorithm trading:

  • Algorithm trading or algo trading is leading to stock price manipulation. The report pointed fingers at certain instances of abnormal market movements in Indian stocks which have been attributed, by market experts, to algo trading/HFT.
  • While huge institutional investors will be able to take advantage of arbitrage of micro and nano-seconds, by engaging in high frequency trades, the interest of retail investors could be jeopardised.