Zerodha co-founder and CEO Nithin Kamath urged his Twitter followers to send their feedback and suggestions to the government in regards to a SEBI consultation paper intent on curbing unregulated algo platforms.
In a two-piece tweet posted on December 10, Kamath wrote: “SEBI has put a consultation paper with the intent of curbing unregulated algo platforms that promise guaranteed returns. But the way it's planned will mean brokers will have to stop offering APIs. This will be 2 steps back in a tech-first future. It would really help if you could send in your feedback and suggestions. The link to the consultation paper is available in the blog post.” (sic)
Kamath also linked his blog post titled 'The rise of Algo trading platforms and everything you need to know', which has been updated on December 9. You can find it here.
In his blog, Kamath explains algos as “software programs that can collect data for a trading strategy, backtest the strategy to see the P&L (profit and loss) historically, and, if required, also automatically trade whenever the strategy generates a buy or sell signal”.
He explained the program removes manual checking of charts to figure out numbers – example the 20-day moving average to deduce the P&L of a strategy in the past and track charts for buy and sell signals.
“Doing this manually is tough and almost impossible to scale since tracking beyond a couple of charts manually is impossible. Instead, a program, or algo, can be used to do this automatically. A strategy can be coded using a programming language or with platforms that allow non-programmers to build strategies with zero or little coding. Such algos can be connected to a dataset to backtest the strategy across many stocks automatically. They could then monitor live market data and generate alerts whenever a buy or sell signal is generated, and with fully automated algos, even automate the order placement completely,” he pointed out.
Kamath in his blog also explains how various platforms use algo and then laid out Zerodha’s stance as follows: (full text of section)
"There has been an increase in the number of these 3rd party algo platforms popping up displaying our logos alongside other brokers. We DO NOT have any partnerships with any of these platforms which offer algos that can automatically trade on a customer’s behalf. If any of them claim to be our partners, they are misleading you. We have been actively asking these platforms to remove any ambiguous mentions of any sort of association with our brand from their websites.
In a technology first world, where we are constantly talking about commoditising access and products, API access or machine readability to one’s accounts should not be privy to a select few. Everyone who wants to should be able to get access to it. Currently, there aren’t any regulations around providing customers access to their trading accounts through APIs. Maybe it should be introduced so that there is no regulatory arbitrage. A simple example is (non-machine-readable) PDF contract notes that are essential for tax filing. Parsing and importing hundreds of such PDFs at the end of the financial year is exceptionally tedious and error-prone. We created machine-readable contract notes that can be imported into tax filing programs via APIs with a single click, a big benefit to our clients.
While there is no systemic risk that these algo trading platforms bring to the markets, they still create financial risks, the biggest one being mis-selling. These platforms may need to be brought under some regulations so that there is accountability. If unchecked, there is a risk of these platforms becoming large by mis-selling and not disclosing the risks, which can, in turn, cause losses to retail customers. The recent phenomenon of the rising number of advertisements for various unregulated financial products may be a sign.
Concerning regulations, I guess these platforms already come under the purview of the current RIA/RA regulations, especially because they collect a fee. RIA (Registered Investment Adviser if you are giving client-specific advice) and RA (Research Analyst) if the advice is for a group of customers. Subscribing to an off-the-shelf algo created by another person that generates a buy/sell signal is very similar to subscribing to a human who tells you when to buy or sell. These platforms probably fit better under the RA framework, which is easier to comply with as well. Explicit regulations will also help these platforms grow without the fear of any regulatory uncertainty.
The 3rd party automation tools that customers run on their computers can’t be monitored or regulated. It is also impossible to regulate or stop all automation tools (bridges) from being distributed for free or sold on the internet. While these may not bring any systemic risk, but platforms that use such bridges to sell automated trading strategies pose the risk of mis-selling and inducing investors to make poorly thought out trading decisions. They should maybe, like explained above, be brought under the RIA/RA ambit.
I just want to remind everyone once again that there isn’t an easy way to make money when trading the markets. While an algo will not be influenced by fear or greed like a human being, markets are super-efficient. If there is an algo or strategy that can make money, enough people will quickly spot it, and soon it stops becoming effective. Another downside of algos is overtrading. A string of 10 trades where you neither make nor lose money could still potentially lose you over 10% just in trading and impact and tax costs, which typically most algo platforms don’t consider when displaying their back tested returns.
If you are interested in coding your technical analysis strategies and backtesting and visualising the P&L without any programming knowledge, check out https://www.streak.tech (a Rainmatter portfolio company). It obviously does not automate order placements; only alerts are generated whenever the strategy generates a buy or sell signal.
If you decide to use strategies built by another person, remember to consider the risks involved and only allocate a small portion of your capital towards them. This is akin to listening to someone else’s financial advice.
Hopefully, this gives you a clearer picture of retail algos and to take better trading decisions."
Meanwhile, the Securities and Exchange Board of India (SEBI) on December 9 released its ‘Consultation Paper on Algorithmic Trading by Retail Investors’. This “seeks comments or views from various stakeholders including market intermediaries and the public on algorithmic trading being done by retail investors including use of API access and automation of trades using the same”.
The paper, in whole, can be read here.
The document explains that the capital markets regulator has from time to time provided broad guidelines on algorithmic trading according to which any order that is generated using automated execution logic shall be known as Algorithmic Trading.
Generally, the features of algo trading include using a defined set of instructions in the form of algos to generate trading signals and placing orders. It noted that:
- The algo trading system automatically monitors the live stock prices and initiates an order when the given criteria are met, and
- This frees the trader from having to monitor live stock prices and initiate manual order placement.
The paper solicited public and stakeholder comments on the proposal which will be taken into consideration. It laid out the channels as follows:
- E-mail to sushmau@sebi,gov.in, with subject as “Algorithmic Trading by Retail Investors” OR
- Send by post, latest by January 15, 2022, to Narendra Rawat, General Manager, Market Intermediaries Regulation and Supervision Department, SEBI, Bhavan II, Plot No.C-7, G Block Bandra Kurla Complex, Bandra (East) Mumbai – 400 051.
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