Is Algo Trading Legal in India?

In recent years, the financial landscape in India has witnessed a significant shift with the rise of algorithmic (algo) trading. This revolutionary approach has gained popularity among Indians as it offers a quicker and more efficient way to execute trades. But with its speed and complexity, one vital question arises: is algo trading legal in India? In this article, we will explore the legal aspects and regulations surrounding algo trading in India.

SEBI's Green Light

Currently, algo trading is legal in India. The Securities & Exchange Board of India (SEBI) has introduced regulations and guidelines to govern algorithmic trading activities in our country. The market regulator issued a comprehensive framework for algo trading in 2012, known as the "Framework for Algorithmic Trading and Co-location”. Initially, only large institutions (banks, investment firms, etc.) were allowed to use algo trading, but by 2016, retail traders were also allowed to participate.

There are no regulations or legislation prohibiting retail traders from using trading algorithms. The rules on algo trading prioritise risk management, including measures to tackle slippage (the difference between the expected price of a trade and the actual price at which the trade is executed) and safeguard against unexpected market fluctuations. Therefore, algo trading is legal in India for both retail investors and institutions.

SEBI's Consultation Paper on Algo Trading:

On December 09, 2021, SEBI initiated a consultation paper on 'Algorithmic Trading by Retail Investors'. They suggested changes for how retail investors use algo trading, especially through Application Programming Interfaces (APIs) for trade automation.

[An API is a set of protocols and tools that enable the software to interact with and place orders on different trading platforms, exchanges, or brokers.]

The paper highlighted concerns about retail investors using API access from stock brokers to automate trades. This often happens through online platforms that offer self-made or ready-made algo strategies without proper approval from stock exchanges. Brokers struggled to differentiate between algo and non-algo orders originating from APIs, causing confusion in regulation.

To address these concerns, SEBI suggested classifying all API-based orders as "algo orders". Brokers would control these orders, with each API getting a unique algo ID from stock exchanges. Brokers would need exchange approval for all algo strategies, whether they're made in-house or by third-party providers. Moreover, brokers would also be responsible for handling any problems investors face.

In a later Press Release on June 10, 2022, SEBI reminded everyone about the risks of using unregulated platforms for algo trading. They warned retail investors to be careful of schemes that promise unrealistically high returns.

Who Can Use Algo Trading Platforms in India?

Institutional investors have more freedom to develop and deploy their own algorithms, often through specialised software. On the other hand, retail investors in India typically rely on pre-built algorithms (mostly offered by brokers). Algo trading platforms allow you to test and execute trading strategies in the live market at lightning-fast speeds. However, some of these platforms have limitations and do not handle complex trading strategies.

What are the Key Regulations on Algo Trading in India?

Here are some of SEBI’s key regulations on algo trading:

• Unregulated platforms: All platforms must obtain SEBI’s approval to offer automated trading strategies in India.
• Past performance claims: SEBI prohibits unregulated platforms or entities from advertising past profits or expected returns from their algorithms.
• Audit Requirements: All algo trading firms must undergo a half-yearly audit, a process exclusively conducted by auditors selected by SEBI.
• Risk Management: Market participants who engage in algo trading must establish a strong risk management system, which includes pre-trade risk checks, post-trade surveillance, and real-time monitoring of trading activities.

The regulatory framework is designed to ensure fair and transparent trading practices and stability of the securities market in India.

The Future of Algo Trading in India

As technology advances and market participants adapt to new challenges and risks, the efficiency and speed offered by algo trading are likely to become even more important to India’s financial landscape.

By understanding the regulations, choosing reliable platforms, and practising due diligence, you can navigate the world of algo trading successfully and potentially improve your trading journey. The future of algorithmic trading in India looks promising, offering exciting opportunities for both individual investors and institutional players.

Also read: What is Algo Trading? How Does it Work?

Important Note: This article is for informational purposes only and should not be considered financial advice. Consult a qualified financial advisor before making investment or trading decisions.