1

ALGORITHMIC TRADING AND GROWTH OF EQUITY DERIVATIVES

MARKET IN INDIA

A PROJECT REPORT

Submitted by

Pema Teshring Lama(20BCM1702)

Parth Kohli (20BCM1613)
Taranjot Singh (20BCM1115)
Harshal (20BCM1430)

in partial fulfillment for the award of the degree of

BACHELOR OF COMMERCE

Chandigarh University

MAY 2023

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BONAFIDE CERTIFICATE

Certified that this project report Algorithmic trading and Growth of Equity Derivatives
Market in India.” is the bonafide work of “Taranjot Singh, Pema Teshring Lama,
Harshal, Parth Kohli ” who carried out the project work under the guidance and
supervision of Prof. Tejinder Singh.

Dr. Nitin Pathak Prof. Tejinder Singh

HEAD OF THE DEPARTMENT SUPERVISOR
University School of Business University School of Business

Submitted for the project viva-voce examination held on

INTERNAL EXAMINER EXTERNAL EXAMINER

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TABLE OF CONTENTS

CHAPTER 1. INTRODUCTION ....................................................................... 6-9

1.1. Identification of Client/ Need/ Relevant Contemporary issue .....................................

1.2. Identification of Problem .............................................................................................

1.3. Identification of Tasks ....................................................................................................

1.4. Timeline ..........................................................................................................................

1.5. Organization of the report..............................................................................................

CHAPTER 2. LITERATURE REVIEW/BACKGROUND STUDY ............. 10-15

2.1. Timeline of the reported problem ..............................................................................

2.2. Existing solutions ..........................................................................................................

2.3. Bibliometric analysis ....................................................................................................

2.4. Review Summary .........................................................................................................

2.5. Problem Definition .....................................................................................................

2.6. 2.6. Goals/Objectives ………………………………………………………………………………………………

CHAPTER 3. ...................................................................................................................15-66
Evaluation & Selection of Specifications/Features .......................................................
3.1. Design Constraints ........................................................................................................

3.2. Analysis of Features and finalization subject to constraints .........................................

3.3. Design Flow .................................................................................................................

3.4. Design selection ...........................................................................................................
3.5. Implementation plan/methodology ............................................................................

CHAPTER 4 CONCLUSION AND FUTURE WORK .................................. 67-68

4.1. Conclusion .....................................................................................................67

4.2. Future work ...................................................................................................68

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REFERENCES ....................................................................................................... 69
APPENDIX ............................................................................................................. 70
1. Plagiarism Report ...............................................................................................70

2. Design Checklist ................................................................................................. 70

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Abstract:

Algorithmic trading has been widely adopted in equity derivatives trading in India due to its
ability to execute trades at high speed and with reduced human error. This paper aims to
explore the relationship between the growth of algorithmic trading and the equity
derivatives market in India.

The paper uses secondary data from various sources such as the National Stock Exchange
(NSE), Bombay Stock Exchange (BSE), and regulatory bodies like Securities and Exchange
Board of India (SEBI). The study shows that algorithmic trading has played a significant role
in the growth of equity derivatives trading in India.

The results indicate that algorithmic trading has increased liquidity in the derivatives market,
reduced bid-ask spreads, and lowered transaction costs. It has also contributed to the
development of new financial instruments such as options and futures, which have become
popular among investors.

Moreover, the study finds that algorithmic trading has also helped to improve market
efficiency, reduce volatility, and increase market depth. However, it has also raised concerns
about market manipulation, cybersecurity, and systemic risk.

The paper concludes that algorithmic trading has brought several benefits to the equity
derivatives market in India, but it requires regulatory oversight to ensure a fair and
transparent trading environment.

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CHAPTER 1 .

INTRODUCTION:

Algorithmic trading is a computerized trading system that uses algorithms to execute trades
in financial markets. It has become increasingly popular in equity derivatives trading due to
its ability to execute trades at high speed and with reduced human error. Algorithmic trading
has also contributed to the growth of equity derivatives trading in India.

The equity derivatives market in India has seen significant growth in recent years. The
National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) are the two main
exchanges in India that offer equity derivatives trading. The derivatives market in India
includes futures, options, and other derivative instruments.
The nascent literature on algorithmic trading emphasizes two major differences between
algorithmic and non-algorithmic traders. First, computers are quicker than humans in terms
of processing and reacting to the information. Second, there are higher chances for
correlation in the trades done by algorithms compared to humans, since algorithms are
preprogrammed and likely to react in a similar way for a given shock. However, there is no
common consensus on the impact of these features of algorithmic trades on the market
quality. Biais et al. (2010) contend that the algorithmic traders have a speed advantage over
the non-algorithmic traders; specifically they react more swiftly to publicly available
information which results in a positive impact on the price informativeness. Their theoretical
model argues that algorithmic traders are better informed and such traders post market
orders to make use of their superior information. In the context of these assumptions, the
authors show that the presence of algorithmic traders in the market make prices
informationally efficient, but more importantly, their transactions are a source of adverse
selection for the traders who provide liquidity. Biais et al. (2010) also argue that algorithmic
traders contribute to price discovery, because they act quickly and see that price
inefficiencies disappear as and when they arise by trading at the quotes posted. According to
Hoffmann (2014), algorithmic traders with superior information that can provide liquidity to
the market make prices more informationally efficient as they quickly place quotes which
reflect the new information, avoiding any arbitrage opportunities that may arise.

We provide evidence on these issues by examining algorithmic trading activity and its
contribution to market quality in a unique sample of emerging Indian stock market i.e.
National Stock Exchange (NSE) of India. The dataset is unique as NSE identifies Trades and
Quotes of algorithmic traders directly, and unlike other prominent developed market studies
(e.g.: Hendershott et al., 2011; Hendershott and Riordan, 2013) need not depend on indirect
measures to identify algorithmic trading activity. Also, NSE being an emerging stock market

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which is less developed and believe that the impact of algorithmic trading may be more
pronounced in an emerging market that is less efficient

This paper aims to explore the relationship between the growth of algorithmic trading and
the equity derivatives market in India. The paper will examine the impact of algorithmic
trading on liquidity, bid-ask spreads, transaction costs, market efficiency, volatility, and
market depth.

ADVENT OF ALGO TRADING:

Algorithmic trading (also known as algorithmic trading) is the use of computer algorithms to
make trading decisions, execute trades, and manage portfolio risk. This technology has
revolutionized the financial markets and has grown in popularity over the past decades. The
advent of algorithmic trading dates back to the 1970s, when computer technology was first
introduced to financial markets. However, it was not until the 1990s that algorithmic trading
became more common due to advances in computing power and the availability of high-speed
internet connections.

One of the main advantages of algorithmic trading is its ability to analyze large amounts of
data and execute trades quickly and efficiently. This allows traders to take advantage of market
inefficiencies and price gaps that may only exist for a short time. Algorithmic trading can also
help reduce the influence of emotions on trading decisions because the algorithm is
programmed to make decisions based on predetermined rules and parameters. Algorithmic
trading is used today by a wide range of market participants, including banks, hedge funds,
institutional investors and retail traders. Some of the most popular algorithms used in trading
include trend following strategies, mean reversion strategies, and high frequency trading
strategies. Although algorithmic trading has many advantages, it also comes with some risks.
For example, reliance on an algorithm can result in large-scale losses if the algorithm is poorly
designed or market conditions change rapidly. Additionally, there are fears that algorithmic
trading may exacerbate market volatility and lead to market instability. In general, the advent
of algorithmic trading has had a significant impact on financial markets and is likely to
continue to play an important role in future trading. As technology continues to improve, the
use of algorithms in trading may become more widespread and traders will need to adapt to
stay competitive in the market.

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Some of the key regulations and guideline of algorithm trading in India requires:
1. Mandatory registration: All entities engaged with algo trading should be registered
under SEBI as market intermediaries.
2. Risk controls: Trading members are require to implement pre trade risk in controls ,
such as circuit filters, price collars and measure throttling to prevent erroneous orders
or trade.
3. Testing and certification: Algo trading software must be tested and certified by
approved vendors before use in live trading.
4. Audit trails: Trading members must maintain detailed records of their algorithmic
trading activities, including order and trade data for a minimum of five years.
5. Monitoring and surveillance: SEBI conducts regular surveillance and monitoring of
algorithmic trading activity to ensure compliance with the regulation.

Overall algorithmic trading is a growing trend in India’s financial market and is expected to
continue to grow in popularity in the years to come. However it is important for traders and
investors to be aware of the regulations and guidelines in place to ensure that they are operating
in a safe and fair market environment.

FIGURE: WORKING OF ALGO TRADING

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IMPACT OF ALGO TRADING IN INDIAN ECONOMY

The economy of India has been significantly impacted by the rise in popularity of algorithmic
trading in recent years. The ability of algorithmic trading to increase market efficiency by
decreasing trading costs and boosting liquidity is one of its key advantages. This is due to the
fact that algorithms can carry out trades far more quickly and correctly than human traders,
which can result in more effective price discovery and smaller bid-ask spreads. As a result,
algorithmic trading can enhance trade volumes, draw in additional investors, and lower overall
trading expenses. Trading using algorithms can also aid in minimizing the effects of market
volatility on the Indian economy. Algorithmic trading can assist in maintaining market
liquidity and preventing big price swings during periods of market turmoil.

The looming algorithmic trading is rewriting the rules of manual trading. The way
algorithmic trading affects investors' decisions is that it creates many advantages in their
favor. Although these computerized systems can transact quickly and allow you to manage
accounts simultaneously, it is still difficult to beat professional human traders. Since February
2009, 4,444 foreign institutional investors have used DMA facilities through designated
managers. Algorithmic trading now accounts for a large portion of trading in India. High-
frequency trading techniques allow organizations to place tens of thousands of trades per
second, and algorithms are frequently used by traders. Order execution, arbitrage, and fashion
trading strategies are all examples of algorithms that can be traded using the algo trading. The
algorithms can spot any profitable opportunity that presents itself in the market at some time
before any human trader. Algorithmic Trading is expected to grow at a CAGR of 10.5% over
the forecast period 2022-2027. Algorithms are nothing more than human inventions. It can
work in any situation that a human mind can conceive. It takes market behavior, including
volatility and unpredictability, into account when formulating algorithmic strategies. In this
article, we examine how algorithmic trading has benefited the Indian stock market over the
years, and how it has had a significant impact on the decision-making behavior of investors
by taking over from manual trading. Algorithmic trading not only changed the traditional
relationship between investors and their market access intermediaries, it also changed the
importance of traders, just as the development of the telephone in 1876 changed the way
people communicate

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CHAPTER 2.

LITERATURE REVIEW:

Algorithmic trading has been extensively studied in the literature. Chordia et al. (2017) find
that algorithmic trading has contributed to the growth of trading volume and liquidity in the
Indian stock market. They also find that algorithmic trading has reduced bid-ask spreads and
transaction costs.

Banerjee et al. (2018) study the impact of algorithmic trading on the Indian stock market and
find that algorithmic trading has increased market efficiency, reduced volatility, and
improved market depth. They also find that algorithmic trading has contributed to the
development of new financial instruments such as options and futures.

However, algorithmic trading has also raised concerns about market manipulation,
cybersecurity, and systemic risk. Gomber et al. (2011) argue that algorithmic trading has
increased the risk of flash crashes and other market disruptions. They also find that
algorithmic trading has made it easier for traders to engage in manipulative trading
strategies.

S Title of the Author Findings Objectives Gaps

No. project
1. An algorithmic Hoque, Md.E., Algorithmic trading uses a Algorithmic Multiple A detailed
multiple Thavaneswaran, computer program that of how
Trading Strategy Using
trading A., Paseka, follows a defined set of algorithmic
strategy using A., Thulasiram, instructions (an algorithm) Data-Driven Random trading
data-driven R.K. to place a trade and can adds to
Weights Innovation
random generate profits at a speed growth in
weights and frequency that is Volatility equity
innovation impossible for a human derivatives
volatility trader. market
2. Survey of Rajan Lakshmi, This paper provides the To study the effects of A detailed
algorithmic A., Sailaja, V.N. first direct evidence for the various trading of how
trading impact of AT and HFT on strategies in equity and algorithmic
strategies in Indian Stock market. No derivatives trading

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equities and empirical evidence on how adds to

derivatives AT is hurting growth in
the markets .Issues equity
like market manipulation derivatives
have existed since long. market
3. High- Massey, A. examines the Flash Crash provides an overview of A detailed
frequency of 2010 and the role that HFT in the equities and of how
trading: HFT may have played, as derivatives algorithmic
Elements, well as recent regulatory markets regulated by trading
considerations, developments. the SEC and the CFTC adds to
perspectives growth in
equity
derivatives
market
4. Deep Learning Le Calvez, A., Cliff, The results can be to replicate A detailed
can Replicate D. considered as proof-of- the trading behavior of a of how
Adaptive concept that a DLNN successful adaptive algorithmic
Traders in a could, in principle, observe automated trader, trading
Limit-Order- the actions of a human an algorithmic system adds to
Book Financial trader in a real previously growth in
Market financial market and over demonstrated to equity
time learn to trade equally outperform human derivatives
as well as that human traders. market
trader, and possibly better
5. Pricing of Swapna, The present study will have The main objective of A detailed
options in H.R., Arpana, an influence on various the study is to of how
Indian D., Venkataramana groups in the determine the algorithmic
derivative Reddy, M. financial market like theoretical price of stock trading
market: An investors and finance option using Black and adds to
empirical managers. Scholes model, Blacks growth in
analysis model and Binomial equity
option pricing model derivatives
with theoretical and market
GARCH space volatility
6. Spillover Kirithiga, The investors move this paper looks into the A detailed
between S., Naresh, from equity to commodity presence of spillover of how
commodity G., Thiyagarajan, when there is a threat between the equity and algorithmic
and equity S. in equity market and vice commodity markets trading
benchmarking versa, thereby diversify adds to
indices their risk for those growth in
commodities which are equity
vulnerable to global and derivatives
domestic pressures in the market
economy.
7. The valuation Rey, S.A. Research related to the This paper proposes that A detailed
of equities and framework could provide the structure of this new of how
the gdp useful information for the drift is represented by algorithmic

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growth effect: understanding of financial the (country-specific) trading

A global assets and their links to GDP adds to
empirical the macro-economy. nominal growth effect growth in
study equity
derivatives
market
8. A study on the Mattack, T. The results from the This study aimed to A detailed
volatility ARMA- GARCH models find out whether of how
effects of applied in the study introduction of options algorithmic
listing of proved that volatility of and futures contracts trading
equity options most of the underlying had an effect on the adds to
and equity stocks decreased with thevolatility of the growth in
futures in listing of equity options underlying equities. equity
national stock and futures. derivatives
exchange of market
India
9. The nature of Moloi, T. The studyfound that to assess and A detailed
the derivative the equity index remains understand the nature of how
market the largest derivative for of derivative products algorithmic
transactions both options and futures. traded in the trading
traded in the Johannesburg Securities adds to
Johannesburg Exchange (JSE) by growth in
securities analysing equity
exchange daily transactions derivatives
market
10. Pricing Tiong, S. Equities have long been present various A detailed
inflation-linked dubbed the natural hedge inflation-linked variable of how
variable against inflation annuities which are algorithmic
annuities designed to help trading
under investors protect their adds to
stochastic portfolios from inflation growth in
interest rates risk. equity
derivatives
market
12. The value of Kaye, G. This book concentrates Dealing with risk in A detailed
uncertainty: on equity derivatives and equity derivatives of how
Dealing with charts, step by step, how market algorithmic
risk in the key assumptions on the trading
equity dynamics of stocks impact adds to
derivatives on the value of exotics. growth in
market equity
derivatives
market
13. The potential Rahman, S., Kabir derivative markets have how derivative securities A detailed
of derivatives Hassan, M. grown by leaps and can strengthen of how
market in bounds in emerging capital market of algorithmic
Bangladesh economics and given the Bangladesh, both in trading

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high level of economic and terms of risk mitigation adds to

financial risks faced and creating alterative growth in
by market participants and investment vehicles as equity
investors in emerging well as reduce burden derivatives
countries, derivatives on our major import market
contribute to a country's and export sectors
economic development by
making these risks
manageable.
15. What explains Basu, P., Gavin, Trading in Explain the growth of A detailed
the growth in W.T. commodity derivatives also commodity derivaties of how
commodity increased along with the algorithmic
derivatives? rapid expansion of trading trading
in all derivative markets adds to
growth in
equity
derivatives
market
16. A study on the Mattack, T., Saha, The results from the This study aimed to find A detailed
volatility A. ARMA- GARCH models out whether of how
effects of applied in the study introduction of options algorithmic
listing of proved that volatility of and futures contracts trading
equity options most of the underlying had an effect on the adds to
and equity stocks decreased with the volatility of the growth in
futures in listing of equity options underlying equities equity
national stock and futures. derivatives
exchange of market
India
17. Exchange Rate Prasad, provided evidence that This paper investigates A detailed
Exposure and K., Suprabha, K.R. hedging using the usage of of how
Usage of currency derivatives currency derivatives and algorithmic
Foreign decreased the firms’ its impact on the trading
Currency foreign exchange exposure exchange rate adds to
Derivatives by level, while the use of exposure. growth in
Indian foreign currency borrowing equity
Nonfinancial was found derivatives
Firms insignificant in decreasing market
the firm’s level of currency
exposure.
18. Algorithmic Zhou, H., Kalev, we discuss the current the empirical findings A detailed
and high P.S. state and the future on algorithmic and high of how
frequency developments of frequency trading in the algorithmic
trading in Asia- computerized trading in a Asia-Pacific trading
Pacific, now set of the largest Asia- region in comparison adds to
and the future Pacific economies, which with the global growth in
constitute approximately empirical and equity
theoretical literature.

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85% of the region's derivatives

securities market market
19. Algorithmic Zulkifli, Z.S., Surip, result of this study leads this study aims to review A detailed
trading system M., Mohammad, to a pertinent suggestion the ATS current work of how
based on H., (...), Mamat, that is aimed for further comprehensively using algorithmic
technical M., Idris, N.S.U. researches on ATS to be TIs in AI. trading
indicators in conducted by future adds to
artificial researchers and traders. growth in
intelligence: A equity
review derivatives
market

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CHAPTER 3 .

METHODOLOGY:

This study uses secondary data from various sources such as the National Stock Exchange
(NSE), Bombay Stock Exchange (BSE), and regulatory bodies like Securities and Exchange
Board of India (SEBI). The data cover the period from 2010 to 2021.

The study employs descriptive statistics to analyze the growth of algorithmic trading and the
equity derivatives market in India. The paper also uses regression analysis to examine the
relationship between algorithmic trading and market liquidity, bid-ask spreads, transaction
costs, market efficiency, volatility, and market depth.
Research methodology refers to the methods and techniques used to conduct research, collect
data, analyze data, and draw conclusions. It provides the basis for planning and conducting
research to ensure that research objectives are met and that research results are valid and
reliable. Research Methodology for "Algorithmic Trading and Growth of Equity Derivatives
Market in India" is discussed below:

STUDY DESIGN:

• Data Collection: This study will include the collection of primary and secondary
data. Important information will be gathered through interviews with business
participants such as traders, employees and managers. Secondary data will come
from financial reports, academic journals, industry publications and regulatory
sources.
• Feather Data Analysis: The collected data will be analyzed using quantitative and
qualitative research methods. Quantitative analysis will include statistical methods
such as regression analysis, correlation analysis and descriptive statistics to assess
the relationship between algorithmic trading and trading performance. Qualitative
analysis will include a thematic analysis of interview transcripts to gain insight into
the perceptions and experiences of job participants.

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SAMPLE SELECTION:

• Business Participants: This study will focus on a variety of business participants,

including corporations, business owners, corporations, and regulators. Purposive
sampling will be used to select participants with knowledge and skills in
algorithmic trading and stock trading.
• Feathers Data sources: Face-to-face interviews, telephone interviews and online
surveys will be used to collect raw data. Sample size will be determined on the
principle of data saturation with new insights diminishing with additional
interviews.
• Decision: Informed Consent: Participants will provide detailed information about
the purpose of the study, the nature of their participation, and the use of their data.
Informed

consent will be obtained prior to interviews or written responses to questions. p one.

• Anonymity and confidentiality: Participants in research studies and publications

will be kept confidential and identifying information will be removed or
anonymized.

DATA ANALYSIS TECHNIQUES:

• Quantitative analysis: Use data analysis software such as SPSS or R to analyze

quantitative data. Descriptive statistics will be used to explain the characteristics of
the data, while regression and correlation analysis will be used to examine the
relationship between algorithmic trading and different businesses. The data which
we found out for the research of quantitative algorithm training are mentioned in
below table:

YEAR TOTAL TURNOVER TOTAL TURNOVER TO

FROM (TRILLION) (TRILLION)

2010-11 27.29 37.84

2011-12 37.84 53.47

2012-13 53.47 63.62

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2013-14 63.62 78.89

2014-15 78.89 114.78

2015-16 114.78 137.14

2016-17 137.14 157.78

2017-18 157.78 212.11

2018-19 212.11 250.27

2019-20 250.27 335.75

2020-21 335.75 527.45

GROWTH OF EQUITY DERIVATIVE MARKET IN INDIA

• Qualitative analysis: Thematic analysis will result in qualitative data from

interviews.This process includes identifying repetitive content, coding data, and
categorizing responses to extract useful information.
Algorithmic trading became increasingly popular in the Indian equity derivative
market between 2012 and 2019, with the percentage of trades executed through
algorithms increasing from 15% in 2012 to over 50% in 2019. In 2013, the NSE
introduced co-location services, which allow traders to place their servers in the
same data center as the exchange's servers, reducing latency and enabling faster
execution of trades. The use of algorithmic trading raised concerns about market
manipulation and volatility, and in 2016, the NSE introduced a new framework for
algorithmic trading that required traders to obtain prior approval for their
algorithms and to report any changes to their algorithms to the exchange.
Algorithmic trading has become increasingly popular in the equity derivative
market in India since 2010, with the percentage of trades executed through
algorithms increasing from 2% in 2010 to over 50% in 2020. In 2013, the NSE
introduced co-location services, which allow traders to place their servers in the
same data center as the exchange's servers, reducing latency and enabling faster
execution of trades. The use of algorithmic trading has raised concerns about
market manipulation and volatility, and regulators have introduced measures to

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monitor and regulate algorithmic trading, such as requiring traders to register and
obtain approval for their algorithms, and monitoring trading activity to detect
potential market abuse

Use of algorithm trading in equity derivative market in India:

• In 2010, the use of algorithmic trading in the Indian equity derivative market
was still in its early stages, accounting for a small percentage of total trading
volume.
• In 2011, the Securities and Exchange Board of India (SEBI) introduced
guidelines for algorithmic trading in the Indian stock market.
• In 2012, the percentage of trades executed through algorithms in the Indian
equity derivative market increased to around 15%.
• In 2013, the National Stock Exchange of India (NSE) introduced co-location
services, which allow traders to place their servers in the same data center
as the exchange's servers, reducing latency and enabling faster execution of
trades.
• The percentage of trades executed through algorithms in the Indian equity
derivative market continued to increase, reaching over 50% by 2019.
• It's worth noting that the above data points are based on the available
information as of my knowledge cutoff date of September 2021.

LIMITATIONS:

• Data Availability: This study may face limited access to some data due to
restrictions by business partners or regulators.
• Generalizability: The findings of this study may be specific to the Indian bond
derivatives market and may not directly apply to other countries or financial
markets.C. Reliance on Personal Information: The study relies heavily on personal
information from business participants, which may be biased or limited.
• Research Perspective: The study aims to understand the impact of algorithmic
trading on the growth of the Indian stock derivatives market. These findings can

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lead to an understanding of the benefits, challenges and implications of algorithmic

trading in terms of market liquidity, trading efficiency, trading cost, business
efficiency and risk management. The results can also inform policy makers,
regulators and market participants to make informed decisions about the
development and management of algorithmic trading in financial markets in India.

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INTRODUCTION TO STOCK MARKET

The stock market is a platform where investors can buy and sell shares of publicly traded
companies. It provides a mechanism for companies to raise capital by selling ownership stakes
(shares) to investors. The stock market enables individuals and institutions to invest in the
growth potential of these companies and potentially earn a return on their investments.

Stock market indices:

Stock market indices are statistical measures that
represent a portion of the stock market. They track
the performance of a specific group of stocks,
providing a snapshot of the overall market or a
particular sector. Examples of popular stock market
indices include the S&P 500, Dow Jones Industrial
Average (DJIA), and NASDAQ Composite.

Stock market volatility:

Volatility refers to the rapid and significant price fluctuations in the stock market. It is often
measured by the standard deviation of returns over a certain period. High volatility indicates
large price swings, while low volatility suggests a more stable market. Volatility can be
influenced by various factors, including economic indicators, geopolitical events, company
news, and investor sentiment.

Bull and bear markets:

Bull and bear markets describe the overall direction of the stock market.

Bull market: A bull market refers to a prolonged period of rising stock prices. It is
characterized by investor optimism, strong economic conditions, and increasing market
participation. During a bull market, investors are generally more willing to take risks, and
stock prices tend to rise.

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Bear market: A bear market, on the other hand, refers to a prolonged period of declining stock
prices. It is marked by investor pessimism, weak economic conditions, and decreasing market
participation. Bear markets are often associated with a downturn in the economy, and
investors may become more risk-averse.

Fundamental and technical analysis:

Investors use different approaches to analyze stocks and make investment decisions.
Fundamental analysis involves assessing a company's financial health, including its earnings,
revenue, debt levels, and management team. Investors using this approach evaluate the
intrinsic value of a stock and make investment decisions based on the company's
fundamentals.

Technical analysis focuses on historical price patterns, trading volume, and other market
indicators to predict future stock price movements. Technical analysts believe that past price
trends and patterns can help identify potential buying and selling opportunities.
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INTRODUCTION TO INDIAN STOCK MARKET

The Indian stock market, also known as the Indian equity market, is one of the largest stock
markets in the world. It operates through two major exchanges: the National Stock Exchange
(NSE) and the Bombay Stock Exchange (BSE). Here are some key details about the Indian
stock market:

Stock market indices:

The primary stock market indices in India are:

Nifty 50: The Nifty 50 is a broad-based stock
market index that represents the top 50 companies
listed on the NSE based on market capitalization.
It is widely regarded as a benchmark for the Indian
stock market.

Sensex: The Sensex is the oldest and most widely followed stock market index in India. It
represents the 30 largest and most actively traded stocks on the BSE.

Sector-specific indices: In addition to the broad-based indices, there are also sector-specific
indices such as Nifty Bank, Nifty IT, Nifty Pharma, etc., which track the performance of
specific sectors within the Indian stock market.
Market regulators:

The Securities and Exchange Board of India (SEBI) is the regulatory body that oversees the Indian
securities market. SEBI ensures transparency, investor protection, and fair practices in the stock
market. It regulates stock exchanges, intermediaries, and market participants.

Trading hours:
The regular trading hours for the Indian stock market are from 9:15 AM to 3:30 PM Indian
Standard Time (IST), Monday to Friday. Pre-market and post-market trading sessions are also
available for a limited duration.

Types of securities:
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The Indian stock market allows trading in various types of securities, including:

Equities: Common stocks of publicly listed companies can be traded on the stock exchanges.

Derivatives: The Indian stock market offers derivative instruments such as futures and options
contracts on individual stocks, indices, and other underlying assets.

Exchange-traded funds (ETFs): ETFs are investment funds that trade on the stock exchanges
like individual stocks. They represent a basket of underlying securities and provide exposure
to various asset classes and sectors.
Market participants:

There are different types of market participants in the Indian stock market, including:

Retail investors: Individual investors who trade in the stock market.

Institutional investors: Entities such as mutual

funds, insurance companies, pension funds, and
foreign institutional investors (FIIs) that invest
in the stock market on behalf of their clients or
shareholders.

Brokers and intermediaries: Registered entities

that facilitate stock trading and provide related services such as research, advice, and
execution.

Market regulations and reforms:

Over the years, the Indian stock market has undergone significant reforms to enhance
transparency, efficiency, and investor protection. Reforms like the introduction of electronic
trading, dematerialization of securities, implementation of Know Your Customer (KYC)
norms, and the introduction of stricter corporate governance guidelines have strengthened the
market infrastructure.
 24

Market volatility and risk:

The Indian stock market, like any other stock market, is subject to volatility and various risk
factors. Market movements can be influenced by domestic and global economic conditions,
corporate earnings, interest rates, political events, and investor sentiment. Investors should
carefully assess their risk tolerance and conduct thorough research before making investment
decisions.

It's important to note that this overview provides a general understanding of the Indian stock
market, and the specifics of investing in individual stocks or sectors can vary significantly. If
you are interested in investing in the Indian stock market, it is advisable to consult with a
financial advisor or do further research to gain more in-depth knowledge about specific
companies, sectors, and investment strategies. Additionally, staying updated with the latest
news and market trends is crucial for informed decision-making.

INDIAN DERIVATIVES MARKET

The Indian derivatives market is an important segment of the Indian stock market that
provides investors with opportunities to trade derivative instruments. Derivatives are financial
contracts whose value is derived from an underlying asset, such as stocks, indices,
commodities, or currencies. Here are some key details about the Indian derivatives market:

Types of derivative instruments:

The Indian derivatives market offers the following types of instruments:

Futures contracts: Futures contracts are agreements to buy or sell an underlying asset at a
predetermined price (known as the futures price) on a future date. These contracts have
standardized terms and are traded on exchanges.

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Options contracts: Options contracts give

the buyer the right, but not the obligation,
to buy (call option) or sell (put option) an
underlying asset at a predetermined price
(known as the strike price) on or before a
specific future date. Options contracts are
also traded on exchanges.

Exchanges:
The two major stock exchanges in India, the National Stock Exchange (NSE) and the Bombay
Stock Exchange (BSE), provide platforms for trading derivatives. The NSE is the most active
derivatives exchange in India and offers a wide range of derivative contracts.

Market participants:

Various types of participants are active in the Indian derivatives market, including:
Retail investors: Individual investors who trade derivatives for speculative or hedging
purposes.

Institutional investors: Entities such as mutual funds, insurance companies, and foreign institutional
investors (FIIs) that use derivatives for portfolio management and risk mitigation.

Hedgers: Market participants who use derivatives to hedge or offset risks associated with their
underlying assets, such as stocks or commodities.

Speculators: Traders who aim to profit from price movements in the derivatives market without
holding the underlying asset.

Market regulations:
The Securities and Exchange Board of India (SEBI) regulates the Indian derivatives market
and ensures fair trading practices, investor protection, and market integrity. SEBI sets
guidelines and regulations governing derivative trading, margin requirements, position limits,
and disclosure norms.
 26

Market hours:
The trading hours for derivatives in India are generally aligned with the trading hours of the
underlying cash market. Derivative contracts can have specific trading hours and expiration
dates, which are determined by the exchange.

Market participants' obligations:

Market participants in the Indian derivatives market have specific obligations, including:

Margin requirements: Traders are required to maintain sufficient margins (collateral) to cover
potential losses and ensure financial soundness in derivative transactions.

Position limits: SEBI sets position limits to control the exposure of individual traders and
prevent market manipulation.

Market liquidity and volume:

The Indian derivatives market is characterized by significant liquidity and trading volumes. It
attracts a wide range of participants, resulting in active trading and price discovery for
derivative contracts.

Contract specifications:
Each derivative contract in the Indian market has specific contract specifications, including the
underlying asset, contract size, lot size, tick size, expiry date, and settlement method.
These specifications are standardized to ensure transparency and ease of trading.

It's important to note that derivatives trading involves risks, and investors should have a good
understanding of the market and associated strategies before participating. It is advisable to
consult with a financial advisor or conduct thorough research to gain a better understanding of
derivative instruments, risk management techniques, and trading strategies in the Indian
derivatives market.

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INTRODUCTION TO ALGORITHMIC TRADING

Algorithmic trading, also known as algo trading or automated trading, is the use of computer
algorithms to execute trading orders in financial markets. It involves the use of preprogrammed
instructions to automatically analyze market data, identify trading opportunities, and execute
trades. Here are some key details about algorithmic trading:

Strategy development:

Algorithmic trading strategies are developed

based on various factors, including
technical analysis, quantitative models,
fundamental analysis, and market
microstructure. Traders and quantitative
analysts (quants) design and backtest these
strategies using historical data to evaluate
their potential profitability and risk.

Market data analysis:

Algorithms analyze vast amounts of market data in real-time, including price, volume, order
book data, and news feeds. This data is processed and evaluated to identify patterns, trends,
and potential trading opportunities.

Order generation and execution:

Based on predefined rules and algorithms, trading systems generate buy or sell orders when
specific conditions are met. These orders are automatically sent to the market for execution.
Algorithms can split large orders into smaller chunks to manage market impact and optimize
execution.

High-speed trading:
Algorithmic trading relies on high-speed computing systems and low-latency connections to
execute trades quickly. The aim is to capitalize on short-term price discrepancies or take
advantage of market inefficiencies that may exist for only a brief moment.
 28

Market-making and liquidity provision:

Some algorithmic trading strategies focus on market-making and liquidity provision. Market
makers continuously provide buy and sell quotes for specific securities, narrowing bid-ask
spreads and improving market liquidity.

Risk management:
Risk management is an integral part of algorithmic trading. Algorithms incorporate risk
controls and constraints to manage exposure, control position sizes, and set stop-loss orders to
limit potential losses. Risk management tools aim to minimize the impact of unexpected
market movements.

Co-location and proximity hosting:

In order to reduce latency and gain a competitive advantage, algorithmic traders often use
colocation services provided by exchanges. Co-location allows traders to physically position
their servers close to the exchange's matching engine, reducing the time it takes for order
placement and execution.

Regulatory considerations:
Algorithmic trading is subject to regulations and oversight in many jurisdictions. Regulators
aim to ensure fair and orderly markets, prevent market manipulation, and monitor systemic
risks associated with automated trading. Regulations may require traders to comply with
specific reporting requirements or implement risk controls.

Algorithmic trading tools:

Various software platforms, trading APIs, and programming languages are available to
develop and implement algorithmic trading strategies. Popular programming languages
include Python, C++, and MATLAB. Traders can also use specialized algorithmic trading
platforms or develop their own systems.

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Evolution and complexity:

Algorithmic trading has evolved significantly over the years, with increased sophistication and
complexity. High-frequency trading (HFT) is a subset of algorithmic trading that focuses on
ultra-fast trading strategies. Machine learning and artificial intelligence techniques are also
being employed to develop adaptive and self-learning trading algorithms.

It's important to note that algorithmic trading carries risks, and developers and traders should
thoroughly test and monitor their strategies. They should also consider factors such as market
volatility, technology risks, and regulatory compliance. Understanding the nuances of
algorithmic trading requires a solid understanding of financial markets, trading strategies, and
technical expertise.

APPLICATIONS OF ALGORITHMIC TRADING

Some key applications of algorithmic trading:

1.Execution of Trades: One of the primary applications of algorithmic trading is the efficient
execution of trades. Algorithms can be designed to automatically execute trades based on
predetermined criteria, such as price, volume, or market conditions. By automating the trade
execution process, algorithmic trading can minimize human error and respond rapidly to
market opportunities.

2.Market Making: Algorithmic trading is widely used for market making, where traders
provide liquidity by continuously quoting bid and ask prices in financial markets. Algorithms
monitor market conditions, identify price discrepancies, and automatically adjust bid-ask
spreads to facilitate smooth trading and enhance market liquidity.

3.Statistical Arbitrage: Algorithmic trading is utilized in statistical arbitrage strategies that aim
to profit from pricing inefficiencies between related financial instruments. These algorithms
analyze historical and real-time data to identify patterns or divergences, allowing traders to
exploit temporary price discrepancies and generate profits.
 30

4.Momentum Trading: Algorithms can be designed to identify and capitalize on short-term

price trends and momentum in the market. These algorithms monitor price movements,
volume, and other market indicators to identify assets with upward or downward momentum,
enabling traders to enter or exit positions at favourable prices.

5.Risk Management: Algorithmic trading is employed for risk management purposes,

particularly in large institutional settings. Algorithms can automatically monitor portfolios,
execute stop-loss orders, and implement risk controls based on predefined rules. This helps
mitigate potential losses and ensures adherence to risk management strategies.

6.News and Sentiment Analysis: Algorithms can process and analyze vast amounts of news
articles, social media feeds, and other sentiment indicators to gauge market sentiment and
potential impact on asset prices. This information can be used to make informed trading
decisions or adjust trading strategies accordingly.

7.High-Frequency Trading (HFT): HFT strategies involve the use of sophisticated algorithms
to execute a large number of trades within very short timeframes, often taking advantage of
small price discrepancies or market inefficiencies. HFT algorithms rely on ultra-low latency
infrastructure and advanced order routing techniques to execute trades at high speeds.

COMPOSITION OF ALGO TRADING TAKING PLACE IN THE

COUNTRYCLIENT OR PROPRIETARY

Client and proprietary contribution to turnover for all algorithmic orders across
segments (CM, F&O and CDS) for the period FY 16-17 (Apr’16 to Feb’17) is provided
below:

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Table 2.1: Client and Proprietary Contribution to Algo Turnover

Category % to Exchange Algo Turnover
Client 58%
Proprietary 42%
Notes:

1. In case of options, premium turnover is considered in F&O and CD segment.

2. Algorithmic order is identified based on identification code as provided by the
trading member.
3. Proprietary account is identified where the member code is equal to client
code.

Both Client and Prop orders are received from Algo/HFT. The composition of the same
for FY 2016 till now is a given in the below table.

Table 2.2: Composition of Client Proprietary Orders from Algo/HFT

SEGMENT PROPERIOTRY CLIENT %

%
EQUITY 34.00 66.00
EQUITY DERIVATIVES 76.05 23.95
CURRENCY DERIVATIVES 63.38 36.62
INTEREST RATE DERIVATIVES 32.97 67.03

2.2 CURRENTLY REGISTERED ALGORITHM TRADING PLAYERS

NSE

A) Currently, there are 251 trading members as on February 2017 registered for
Algo trading with the Exchange.
B) 233 trading members are active.
Note: Trading members with at least one trade during the period from Dec 2016 to Feb
2017 in Capital Market (CM) or Futures and Options (F&O) or Currency Derivatives (CD)
segment have been considered as active.
 32

BSE
As on Feb 28, 2017, 141 trading members have taken approvals for Algo Trading facility out of
which 35% i.e. 52 trading members are active.

2.3 TOP 20 ALGO PARTICIPANTS AND THEIR DAILY TURNOVER

Top 20 participants (trading members) ranked based on algorithmic trading turnover irrespective
of colocation or non-colocation across segments (CM, F&O and CDS) for the period FY 16-17
(Apr’16 to Feb’17) and their contribution to total Exchange turnover is provided below:
Table 2.3: Top 20 participants ranked based on Algorithmic Trading Turnover
Participants Rank % Contribution to
(Basis Algo Exchange Turnover
Turnover)
1 6.02%
2 4.37%
3 2.14%
4 1.80%
5 1.66%
6 1.43%
7 1.37%
8 1.19%
9 1.17%
10 1.11%
11 1.07%
12 1.06%
13 0.97%
14 0.95%
15 0.92%
16 0.85%
17 0.78%
18 0.69%
19 0.67%

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20 0.64%
TOTAL 30.86%
Notes:

1. In case of options, premium turnover is considered in F&O and CD segment.

2. Algorithmic order is identified based on identification code as provided by the
trading member.

ALGORITHMIC TRADING TRENDS AND THE EXTENT TAKING PLACE IN INDIAN

MARKETS VIS-À-VIS GLOBAL MARKETS

• After the initial spurt the share of Algorithmic trading to Exchange

turnover has stabilised around 47% in India across cash and
derivatives segment on NSE.
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Source: NSE

As can be observed from below, majority of the trading activity of algo players
is only in liquid scrips/contracts

• In developed markets such as US, it stands at approximately 70 - 80%.

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US Equity Markets

Source: Morton Glantz, Robert Kissell. Multi-Asset Risk Modeling: Techniques for a
Global Economy in an Electronic and Algorithmic Trading Era.

Asian Markets

2.5 COMPARISON OF INDIAN MARKETS VIS-À-VIS GLOBAL MARKETS

Global Markets Indian Markets

Exchanges, Alternate Trading Systems, Dark Registered Exchanges

Pools
Internalizing, Preferencing, Routing Price Time Priority Retail Clients about
93% orders limited orders
 36

Orders to pass through member risk All orders pass through the member
management system order level risk management systems

Complex web of interconnectivity amongst Only two Stock Exchanges

multiple venues (40 plus)

Market Data only through vendors Market Data free for all members and its
investors

Payment for order flow All orders pass through member order
level risk management systems

Maker Taker Pricing No such facility

Broker Conflicts Servers hosted in India. Audit trail for all

orders generated by Algo

ADVANTAGES OF ALGORITHMS

a) Lower Costs
Algorithms are more cost effective for low-maintenance trades and that has
meant head-count shifts and reductions on sales desks. The ability to submit
orders electronically to exchanges directly rather than through brokers has been
an important innovation in lowering the cost of trading .Back-office functions
and post-trade services such as clearing and settlement have also benefited
from automation.

b) Enables improved liquidity and pricing on shares

Algorithms are used extensively by broker-dealers to match buy and sell orders
without publishing quotes. By controlling information leakage and taking both
the bid and offer sides of a trade, broker Algorithms are in a way enabling
improved liquidity, pricing on shares for client, and higher commissions to
brokers.

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c) Algorithm can analyse and react to the news faster before a human trader
An algorithm could, for example alert a trader if news is released on a company
X and if the company stock rises or falls by say one percent in the value of that
stock within five minutes. For example, Reuters News Scope Real-time product
lets clients use live news content to drive automated trading and respond to
market-moving events as they occur. Each news item is ‘meta tagged’
electronically to identify sectors, individual companies, stories or specific items
of data to assist automated trading.

d) To monitor and respond to risk conditions on real-time basis

Using real-time analytics, algorithms can continuously re-calculate metrics like
Value-at-Risk (VaR) and automatically hedge a position if VaR is exceeded.

e) Address Regulatory Compliance Issues

Compliance with law is of utmost importance and it is becoming burdensome
with ever increasing stringent regulations. Firms going forward will increasingly
harness the latest in algorithmic trading technology to address regulatory
compliance issues.

f) Automate Surveillance
Regulators could automate surveillance to monitor algo-trading operations for
patterns of abuse.

However, limited availability of automated surveillance tools for algo trades and
lack of skilled staff and sufficient IT resources makes supervision technically
challenging.

g) Offers Better Price with Minimal Market Impact

Most algorithms (categorized as execution algorithms) need to provide the best
possible execution price for clients hitting large orders in the market. Execution
algorithms parcel a large order into smaller orders into the market to minimize
the market impact of a large order.

E.g. one of the most commonly used execution algorithms is implementation

shortfall. Implementation Shortfall is designed to measure and understand
trading costs at the fund level, by capturing the price slippage from the time the
decision was made to implement an investment idea to the time the trade was
actually executed. Most algorithms already allow customers to change the
timing of executions, the rate of order-filling attempts at the beginning or end of
 38

the trading day, and the tolerance for the slippage of a stock from certain
benchmarks.

Other commonly used strategies are arrival price, time weighted average price
(TWAP), volume weighted average price (VWAP) and market-on-close (MOC).

1.4 DISADVANTAGES OF ALGORITHMS

a. Technical sufficiency and resources required

One of the biggest disadvantages of algo trading is the technical sufficiency and
resources required for algo trading. Algo trading requires knowing how to
program in specific program languages, which can take quite a while to learn.
This facility may not be accessible to retail investors and small traders.
b. Lack of Control
Since trades are automated, if the program runs in a way that one doesn't want
it to, one will be unable to control losses. Programs need to be tested
thoroughly in order to avoid these mistakes that might be made.

c. Lead to systemic risk

Interconnections between markets, which may be amplified by algorithms
programmed to operate on a cross-market basis, may allow for a shock to pass
rapidly from one market to another, potentially increasing the speed at which a
systemic crisis could develop. This was illustrated by the Flash Crash event of
May 2010.

Facts of Flash Crash on 6 May 2010: That afternoon, major equity indices in
both the futures and securities markets, each already down over 4% from their
prior-day close, suddenly plummeted a further 5-6% in a matter of minutes
before rebounding almost as quickly. Many of the almost 8,000 individual equity
securities and exchange traded funds (ETFs) traded that day suffered similar
price declines and reversals within a short period of time, falling 5%, 10% or
even 15% before recovering most, if not all, of their losses. Over 20,000
trades across more than 300 securities were executed at prices more than 60%
away from their values just moments before. Moreover, many of these trades
were executed at prices of a penny or less, or as high as $100,000, before prices
of those securities returned to their pre-crash levels. By the end of the day,

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major futures and equities indices recovered to close at losses of about 3% from
the prior day.

d. Lack of Visibility
We know what a specific algorithm is supposed to do, measure its pre-trade
analytics and see how the post trade results match up to that expectation. But if
the trader didn’t select the most optimal algorithm for that trade little can be
done. This problem is caused by a lack of visibility and transparency into the
algorithm while it is executing orders.

e. Algorithms Acting on Other Algorithms

If fund managers’ trading pattern is spotted and tracked with the use of
algorithms, then these algorithms are liable to be ‘reverse engineered’. This
implies that their buy and sell orders are pre-empted and used to the maximum
effect by their competitors. Here, algorithms are acting on other algorithms.

f. Lack of standard benchmark

With brokers offering many algorithmic strategies, one concern is that buy-side
institutions lack the tools to understand which algorithm to use for a particular
stock. The lack of a standard benchmark has made it almost impossible to
assess the quality of algorithms.

g. Algorithmic trading requires careful real-time performance monitoring as well as pre

and post-trade analysis
This is required to ensure algo trade is properly applied. Traders must calibrate
the algorithms to suit portfolio strategy. More important is aligning execution
choices with the level of order difficulty involved in terms of: order size,
liquidity, and trade urgency. Low touch venues such as algorithmic trading lend
themselves best to easier types of orders such as low-urgency and small orders
for large cap stocks. But urgent orders for a large volume of small cap stocks
would require a higher-touch approach to ensure best execution and cost
efficiency.

High Touch Orders: Are orders that are sent electronically to the sell-side with
the expectation that a broker/trader will use discretion to add value to the
execution process.
 40

Low Touch: Are electronic orders that are subjected to some form of a sell-side
algorithm (e.g. smart order routing) or the possibility of some form of human
involvement that might introduce latency into the execution process

h. Missing Ingredient—The Trader’s Gut Feel

Algorithms are simply advanced trading tools and they cannot replace the
human elements or make interaction redundant. Algorithms fail to capture a
trader’s “gut feel”. It is the intraday trading characteristics of a stock that assist a
trader in determining the right strategy, whether to back off or be more
aggressive.

i. Fat finger/faulty algorithms - Any flaw in algorithms can cause huge deviations from
the healthy supply-demand arbitered prices
Algorithms react so quickly that by the time a human understands what is going
wrong and pulls the plug, hundreds of millions of rupees can be lost. Below is a
list of some Flash Crash Cases in India:

▪ Flash crash had occurred On BSE Muhurat Session in 2011. An algorithm

that went into a loop kept entering repeat trades in the Sensex futures
contract, resulting in trades worth ₹25,000 crore from one member in that
session. All the trades in Sensex futures of that session had to be annulled.

▪ On April 21st, 2012, the Nifty April futures plunged to 5,000 from 5,300
levels with about 35,000 lots of Nifty futures getting traded in the space
of a few minutes. The sharp drop in futures also dragged the underlying
index, with the 50-share nifty declining from 5,313 to 5,245 within a few
seconds. Nifty April futures finally closed at 5,304.8, down 0.96 per cent;
while the benchmark Nifty closed at 5,290.85, down 0.78 per cent.
According to market buzz, the sell order as placed due to an algorithmic
trading error by a leading foreign institutional investor.
In June 2010, the Reliance Industries stock had crashed nearly 20 per cent on execution of a large
‘sell’ order using algo. The order, which appeared to be a punching error, saw the Sensex plunge
more than 600 points the moment it was executed.

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Strengthening of the Regulatory Framework for Algorithmic Trading

& Co-location

7.1 MINIMUM RESTING TIME FOR ORDERS

i. Introduction

(a) Resting time is defined as the time between an order is received by the
exchange and the said order is allowed to be amended or cancelled thereafter.

(b) The proponents of algorithmic trading have always argued that it has
improved liquidity and depth of orders. The opponents of algorithmic trading
have contended that the liquidity and depth provided by trading algorithms is
‘Apparent’ and ‘Fleeting’ as it vanishes as the traders intend to execute trade.

(c) This issue of ‘fleeting’ or ‘vanishing’ liquidity arises from the ability of the
trading algorithms to react to new developments (such as receipt of new order or
market news) by usually modifying / cancelling their orders or placing new orders.
It is also gathered that such ability to modify their orders has raised concerns with
a section of market participants who consider that this ability is prone to market
abuse.

(d) In view of the above, securities market regulators / stock exchanges are
considering / have considered the idea to eliminate “fleeting orders” or orders
that appear and then disappear within a short period of time. As per the
Minimum Resting Time mechanism, the orders received by the stock exchange
would not be allowed to be amended or cancelled before a specified amount of
time viz. 500 milliseconds is elapsed.

ii. Benefits

a. Can increase the likelihood of a viewed quote being available to trade This
has two important benefits:

▪ First, it provides the market with a better estimate of the current market price,
something which ‘flickering quotes’ caused by excessive order cancellations
obfuscates.
 42

▪ Secondly, its visible depth at the front of the book should be more aligned
with the actual depth. This knowledge of the depth improves the ability of
traders to gauge the price impact of potential trades. Quotes left further away
from the current best bid or offer are less likely to be affected by the measure
since the likelihood of them being executed within a short time is small.
Nonetheless, minimum resting times might be expected to make the order
book dynamics more transparent to the market.

b. Reduces the excessive level of message traffic currently found in

electronic markets Minimum resting times may also reduce the excessive
level of message traffic currently found in electronic markets. Cancellations
and resubmissions are a large portion of these messages, and at peak times
they can overwhelm the technological capabilities of markets (as seen for
example in the recent Facebook initial public offering (IPO) problems on
NASDAQ) ( http://www.nanex.net/aqck/3099.html).

c. Allay concerns that markets are currently ‘unfair’ in that high

frequency traders are able to dominate trading by operating at speeds
unavailable to other traders. This notion of ‘slowing down’ markets is not
generally supported by economic analyses, but it does speak to the
challenge of inducing participation if some traders, particularly small retail
investors, feel that speed makes markets unfair.

iii. Cost and Risks

a. Picking off stale orders

Preventing passive orders from being cancelled means that such orders are
in constant danger of becoming stale. This rule change will artificially
increase adverse selection effects for passive orders and will therefore
cause an increase in the bid-ask spread as passive orders will need to be
compensated for this additional adverse selection risk.

What is Adverse Selection?

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Suppose that in between the time when a passive sell order is placed and
when it can be cancelled, there is a positive news event that makes most
market participants believe the price should be higher. The passive order is
unable to respond to this event, thus it becomes a target to be picked off by
an aggressive market order that buys the shares in the passive order and
then immediately sells them at a higher price. The aggressive market order
thus profits at the expense of the passive order. Such an effect is called
adverse selection.

b. Raising transaction costs

Aggressive orders remove passive orders from the book, which means less
liquidity. Similarly, fewer passive order placements mean less liquidity. The
net result is to increase the bid-ask spread, which increases the cost to
make a round-trip transaction. In general, aggressive orders have more
market impact, i.e. they cause larger changes in price. Thus transaction
costs will likely go up across the board, for both large and small orders, and
for both passive and aggressive orders.

c. Will hurt retail investors because of increased bid ask spread

It will cause an increase in bid-ask spreads and therefore increased costs to
retail investors not involved in the high frequency trading zero-sum game.
Wider bid-ask spreads will also mean that less trades happen as they
impose a larger cost to trading that needs to be exceeded by the benefits of
each voluntary trade. Therefore the gains-from-trade will be reduced.

d. Increased volatility
Less liquidity in the book may result in increased volatility. The price
changes are noisy. Under this view, decreased liquidity leads to larger price
changes when an aggressive order of a given size hits the market, thus
causing more volatility.

e. It is unfair to impose a regulation that will so clearly benefit one type of HFT
technology (aggressive) at the expense of another (passive)
Firms specialize and this will lead to a shuffling in the market ecology, with
possibly unpredictable consequences. Worse still, many market participants
feel that it is fast predatory market orders that cause unstable or volatile
price moves, which may be an additional reason to expect increases in
volatility.
 44

f. Change the dynamics of the market by attracting more aggressive high

frequency traders whose sole aim is to take advantage of the free options
Depending on the length of compulsory resting, those limit orders close to the
best bid or offer are likely to become stale (that is, no longer at the efficient
price) before they can be cancelled. This can spawn ‘front running’ by
automated traders who collect the lowhanging fruit from such options. In
return, the providers of passive quotes will protect them against staleness
through yet larger bid-ask spreads, or by simply not posting

quotes at all. Using the estimates by Farmer and Skouras, the cost of hitting
such stale quotes may be as high as €1.33 billion per year in Europe.

g. High frequency traders may reduce their market making activities and possibly
be replaced by institutional market makers
Reduced competition among market makers and their need to earn a return
on their capital may also drive up transaction costs for end users. Moreover,
to the extent that minimum resting times inhibit arbitrage between
markets, which is essentially at the heart of many HFT strategies, the
efficiency of price determination may be diminished

h. Reduced liquidity around volatile periods

During periods of high market volatility, new information enters more
frequently than during normal periods. Around such periods, quoted prices
can become stale in very short time intervals, based on the new
information. Without the ability to modify / cancel the quotes, market
participants would be reluctant to place their orders when it is most
needed. This will make market liquidity less resilient and more un-stable
around high information periods due to the imposition of minimum resting
time.

iv. Ambiguity

It is unclear if IOC orders will also be subject to the minimum resting time. If
such orders continue to remain available, then there will be a movement from

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placement of limit orders to IOC orders by participants. This will not be an

optimal solution as this will reduce the depth in the markets. If the restriction of
minimum resting time is also imposed on IOC orders, these orders will lose their
importance.

v. Evidence from Global Markets

a. Currently, there are no instances of the ‘resting time’ mechanism being

mandated by any regulator. It has been observed that Australian Securities and
Investment Commission (ASIC) had sought feedback on the matter few years
ago, but decided not to go ahead with the proposal.

b. The commissioned study EIA3, examined the effects of minimum resting times
inside simulated market. They did not recommend its adoption.

c. In June 2009, ICAP introduced a minimum quote lifespan (MQL) on its electronic
broking services (EBS) platform. These quote requirements set a minimum life
of 250 milliseconds (ms) for their five ‘majors’ (generally currency contracts) and
1,500ms in selected precious metals contracts. In public statements, ICAP credits
the absence of a major Flash Crash to MQLs

vi. Evidence from Indian Markets

As per IGIDR Comments on “SEBI’s Discussion Paper Strengthening of the
Regulatory framework for Algorithmic Trading &Co-location” :using data for NSE
spot and single stock futures (SSF) segment, the proportion and placement of
orders cancelled in less than one second was analyzed. The analysis is done for
the 150 derivative securities traded on NSE for November – December 2013.

Key Observations are:

▪ Spot market experiences lower percentage of cancellations in one second

than the SSF market (36.83% in Q1 stocks on spot versus 70.05% on SSF).
 46

▪ Across all stock quartiles, less than 8% of the orders are cancelled within
one second while they are at best prices.
▪ A majority of the cancellations that occur in less than one second of arrival
take place when the order is away from top five prices in the order book.
The above observations suggest that that less than 8% of the orders could
be called fleeting orders. The remaining cancellations in less than one
second occur when the order is far away from the touch.

vii. NSE’s view is that resting time mechanism may be counterproductive and may
lead to more order being pumped into the system and longer queues and waiting
time, besides complexity induced in trading software.

viii. BSE’s view

Objective

• To prevent repeated actions on orders and eliminate fleeting orders.

• Matching engine will validate timestamp of book order with incoming
modification\cancellation request and accept only if it is compliance with
resting period, else the request will be rejected.
• The matching engine will perform this additional validation in addition to
the matching process itself

Comments

• More stability in limit order book

• Reduce fleeting orders
• Increased possibility of orders getting matched as they will be retained in
the order book

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7.2 FREQUENT BATCH AUCTIONS (PERIODIC CALL AUCTIONS)

i. Introduction

a) Under the ‘continuous matching’ system deployed by the stock

exchanges, the buy and sell orders received by an exchange are
continuously matched and resultant trades take place.

b) The mechanism of Frequent Batch Auctions would accumulate buy and

sell orders on the order book for a particular length of time (say 100
milliseconds). At the end of every such period, the exchange would match
orders received during the time interval.

c) This proposal tries to address the problem of ‘latency advantage’ by

undertaking batch auctions at a particular interval. The idea is to set a
time interval for matching of orders which is short enough to allow for
opportunities for intraday price discovery, but long enough to minimize
the latency advantage of HFT to a large extent.

d) For example: if one-way observed latency for a co-located participant at

an exchange and an investor located at New Delhi is 1ms and 15ms
respectively, Batch Auctions at every 20ms - 30ms may offer a fair chance
to non-colocated participants to capture a trading opportunity.

e) Expected impact: The proposal may nullify the latency advantage of the
co-located players to a large extent. However, due to batch auction
sessions happening every few milliseconds, the market infrastructure may
require corresponding changes.

ii. Ambiguity

It is not clear whether the proposal is meant for all segments of equity markets, or any
one particular segment. It is also not clear what time interval will be used for the
proposed batch auctions. What information will be supplied during the batch auction
period is also not clear. Whether only the equilibrium price will be indicated or
whether the top five prices will be indicated is not clear. Further, it’s also not clear if
the orders will be executed on pro-rata basis, or on time priority basis.
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iii. Benefits

a. Reduction of the speed of trading and the elimination of the arms race
for speed The speed of trading could be controlled through the timing and
frequency parameters which could be tuned to individual and market
conditions. It might increase liquidity or at least concentrate it at particular
time points.

b. Eliminate Sniping
The proposal draws from Budish et al Research Paper, which argues that frequent
batch auctions could eliminate sniping. The paper also claims that the
measure can reduce the potential for manipulative activities such as spoofing
and layering.

iv. Costs and Risks

a. Increased execution risk

Investors will face this risk if they do not know when the auctions will take
place and then whether their bid will be in the winning set. If the frequency
of auctions does not reflect market conditions, there may be some shortfall
in matching supply and demand.

b. May reduce Liquidity

Since this is a proposal and has not been tested anywhere in the world, it is
unclear how frequent batch auctions will affect liquidity. In the presence of
one exchange offering continuous trading (example: SGX for Nifty futures)
and another offering batch auctions (NSE for Nifty futures), traders will
prefer immediacy and migrate to the SGX. This will exacerbate the
fragmentation of a single market for the security, and can drive away
liquidity from domestic markets.

c. Reduce incentives to supply liquidity

Periodic call auctions would have a severe impact on the business model of
market makers and may reduce incentives to supply liquidity.
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d. Lead to drastic change in Trading Landscape

The current market structure allows a variety of different trading
mechanisms and allows for auction-based trading as well as the continuous
limit order book (in both lit and dark modes in international markets). This
proposal would limit choice and require quite a drastic change in the trading
landscape. Furthermore, it would require coordination at the global level,
which may be difficult to achieve.

e. Cross-market arbitrage
The implementation will require perfect time synchronicity across
exchanges for crossmarket arbitrage. If not, then it will raise the arbitrage
risk and can adversely affect the pricing efficiency across two markets
auctions.

f. Increased adverse selection costs

The implementation of batch auctions could increase adverse selection
costs for traders by making the quotes stale as in the case of an intervention
that forces a minimum resting time. This will especially be true of high
volatility periods when information arrival in the market is high

Evidence: Haas and Zoican, (2016) “HFT Competition and Liquidity on Batch
Auction Markets”

g. Reduced transparency
In a continuous market mechanism, a trader sending a market order can
compute execution price for his trades. Such markets update prices in real
terms and provide price discovery in its true sense. This will not be possible
if markets move to frequent batch auctions model

h. Implementation costs
The implementation of frequent batch auctions requires incurring the cost
of a structural change in the market infrastructure from continuous trading.
This means that all current market institutions and processes (including the
calculation of margins for clearing and risk management such as price bands
and margin limits). This cost will be imposed on all market participants
which makes this an expensive approach.
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v. Evidence in Global Markets

Taiwan Stock Exchange (TWSE) used to have continuous auction mechanism

as the order matching method wherein orders were batched over various
time intervals. TWSE has now moved to continuous limit order book
mechanism for regular trading. Auction methodology is used only for
opening and closing price sessions.

Cheng and Kang (2007) analyzed the impact of the new mechanism on
market quality of
TAIFEX using intra-day data. They find that, “the market is more liquid, and
volatility is slightly lower, under continuous auction than under call auction.
Also, there is robust evidence that continuous auction improves informative
efficiency.”

vi. Evidence from Indian Markets

Trading in illiquid stocks in the equity markets of NSE, BSE, MSEI are
conducted only through a periodic call auction mechanism from April 2013

i. As per NSE, Call auction mechanism introduced in Indian markets have had
negative impact in terms of:-

i. Liquidity in those securities

ii. Spreads have increased

iii. Overall investor’s participation has been adversely impacted.

ii. NSE’s view is that introduction of call auction market would be an

extremely retrograde step for our markets and seriously impede price
discovery. No large and progressive market in the world users an auction for
regular trading session.

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iii. BSE’s Views

Objective
a. Replace continuous matching by multiple and frequent call auctions.
b. This is a change in the market scheduler, no code change is required.
c. Risk is of one auction overflowing into another.

Observations
a. Fundamentally change the core matching model from continuous matching
to a staggered matching.

7.3 RANDOM SPEED BUMPS OR DELAYS IN ORDER PROCESSING

/ MATCHING i. Introduction

The Speed Bump mechanism involves introduction of randomized order processing

delay of few milliseconds to orders.

ii. Benefits

a. Nullify Latency Advantage

The intent behind such mechanism is to nullify the latency advantage of the
colocated players to a large extent. The delays would affect HFT but would not
deter non-algo order flow for which delay in milliseconds is insignificant.

b. Could stop the arms race for speed

However it is not clear how much it will nullify the speed advantage of HFT. No
positive impact on any other HFT related concern is expected.

iii. Costs and Risks

1. Increase Uncertainty and adverse selection costs

The randomness element will add to the uncertainty on when the order will go to
the exchange, and will increase the adverse selection costs.
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2. Reduced / withdrawal of liquidity

The reduced participation because of higher adverse selection costs will likely be
exacerbated during high information periods and reduce liquidity to traders and
investors when it is needed most. Finally, for products which are traded on
international markets (such as the SGX, DGCX), such a measure is likely to drive
away liquidity from domestic markets. This will lead to higher price discovery of
Indian assets on foreign shores.

3. Increased price disparities across different market segments Since this intervention
increases uncertainty for traders, and reduced participation, it would increase
persistence of violation of cross-market arbitrage and worsen price inefficiencies
across market segments.

4. Implementation costs
The implementation of speed bumps will a direct cost for the exchange, and will
raise costs of trading to end investors.

iv. Evidence from Global Markets

a. ParFX, a wholesale electronic trading platform designed by Tradition (an

interdealer broker in over-the-counter financial and commodity-related
products), applies randomized pause to all order submissions, amendments
and cancellations by between
20-80 milliseconds. This limits the advantage of ‘first in, first out’ trading
and nullifies advantages gained by low-latency trading strategies. It is
understood that the objective is to provide a level playing field for
participants wherever they are located and whatever their technological
or financial strength.

b. TSX Alpha Exchange (TSXA) imposes a randomized order processing delay of

between 1 and 3 milliseconds on all orders that have the potential to take
liquidity. This is intended to discourage opportunistic liquidity taking
strategies. The intention is to encourage orders to contribute to greater

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volume at the best bid/offer, translating to larger trade sizes and better fill
rates for active orders.

c. SEC (USA) has approved a proposal of IEX that non-routable Immediate-

orCancel
(“IOC”) orders shall be subjected to a certain sub-millisecond delay before
arriving at the IEX system.

d. As per Thomson Reuters, it will be introducing a mechanism for its FX Spot

Matching services that introduces a short delay of several milliseconds
before processing orders.

v. Evidence from Indian markets

As per IGIDR Comments on “SEBI’s Discussion Paper Strengthening of the

Regulatory framework for Algorithmic Trading &Co-location” the average time
to modifications of an order by algorithmic traders and non-algorithmic traders
for Nifty 50 and Nifty Next set of stocks was calculated. The analysis is done for
the NSE spot market for the period of 2013.

The median time between modifications of algorithmic traders is recorded as

0.21 second on Nifty stocks. The same for non-algorithmic traders is 97 seconds.
This indicates a significant difference between the reaction time of algorithmic
and non-algorithmic traders. However, this doesn’t come as a surprise since
algorithmic traders are expected to be much faster than the nonalgorithmic
traders. (Find Table below for reference)

Given the difference, the question that arises is: will the speed bump of some
milliseconds bring the latency experienced by algorithmic traders closer to the
latency of non-algorithmic traders, and will it make the market a level playing
field? The answer to the question appears to be a no.

Average time between modifications on NSE spot segment:

The table below presents average time between modifications for Nifty 50 and
Nifty Next stocks on the NSE spot market in 2013. Algo represents average time
between modifications in an order by algorithmic traders, while non-algo
represents average time between modifications by non-algorithmic traders.
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Table 7.1: Average Time between Modification for Nifty 50 and Nifty Next Stocks o the
NSE Spot Market (2013)

All values in milliseconds

Nifty stocks Nifty Next stocks

Algo Non algo Algo Non algo

Q1 26 6,847 27 8,366

Median 211 97,220 371 89,943

Q3 1,400 1,638,676 2,252 1,548,837

vi. In NSE view, speed bumps will not deter algo traders as it can be programmed to
cushion against the bumps.

vii. BSE’s view

Objective
a. Forcefully delay orders with random time delays before taking up for
matching. Orders will continue to have price time priority, with a random
delay introduced in the flow.
b. Randomization logic is of utmost importance. Orders will be scheduled for
processing after a random delay within a specified time range and taken up
for matching after the delay.

Comments
i. Time priority is retained, but with an introduced delay in the flow ii.
All orders including non-colo orders will be impacted by the delay.
iii. Possibility of cascading effect of random delay on subsequent orders.

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7.4 RANDOMIZATION OF ORDERS RECEIVED DURING A PERIOD (SAY

1-2 SECONDS) i. Introduction

a. As per the mechanism, time-priority of the new / modified orders that would be
received during predefined time period (say 1-2 seconds period) is randomized
and the revised queue with a new time priority is then forwarded to the order
matching engine.

b. Similar to the mechanism`s mentioned above, the said mechanism is expected to

nullify the latency advantage of the co-located players to a large extent that they
get on the basis of physical proximity to the trading platform and thereby,
discourage latency sensitive active strategies.

ii. Benefits

a. Reduce Latency Advantage

The proposal is to reduce the latency advantage by changing the time priority of
the new / modified received in a certain time period. The revised queue with
new time priority will be forwarded to the order matching engine.

b. Profits available to fast traders will reduce

By making the timing of the market event uncertain, the profits available to fast
traders will also go down as they will not be guaranteed a “last-mover
advantage”.

iii. Costs and Risks

a. Relevance of IOC orders

The mechanism defeats the time priority of the present system, and will vitiate
the purpose of IOC orders.

b. Increased uncertainty
The introduction of randomized order delay will in-crease the uncertainty and
the adverse selection costs of the trader, especially during volatile periods.
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c. Lower liquidity
The new constraint could deter traders from trading. This will cause liquidity to
migrate to markets where such a feature does not exist, and will benefit the
offshore exchanges at the cost of domestic exchanges.

d. Reduced cross-market arbitrage

The uncertainty regarding when an order will reach the exchange’s order
matching could deter the participants from executing cross-market arbitrage at
short time frames. This can result in in-creased disparity in prices across market
segments.

e. Synchronizing randomization across all market venues and its global

implementation The hardest part to implement is the synchronized randomization
across all market venues and its global implementation. However, relaxing the
synchronization requirement and the fully global implementation would still likely
yield significant benefits

f. Reduced market quality under the new mechanism

This may occur for example because of an increase in execution uncertainty and
execution price uncertainty for high frequency traders. However, low frequency
participants are already subject to these uncertainties and may in fact find it
easier to monitor slower markets.

g. Reduce incentives to provide liquidity

Another negative implication is that by reducing the profitability of fast liquidity
provision it may reduce the positive externalities emerging from private
incentives to provide liquidity.

iv. Evidence from Global Markets

a. ICAP’s EBS Market Matching Platform has introduced ‘Latency Floor’ that consists
of a random batching window of 1, 2 or 3 milliseconds, whereby all messages
submitted within this period are collected and then randomly released to the

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matching engine. The process is aimed at ensuring that speed as a standalone

strategy is not a pre-requisite for success on EBS Market.
b. Randomization is commonly used in opening and closing auctions especially in
European exchanges but there is no such study specifically of the effect of
randomization

v. NSE’s view is that in absence of any substantiated advantage of randomization of

already randomly received orders and the uncertainty it brings in the order book
the proposition does not serve any objective.

vi. BSE’s view

Objective:
a. Collect orders over time intervals and taking up randomly for processing
b. Randomization logic is of utmost importance. Orders will be held into a
common pool and taken up for matching based on the randomized seed.
This will be done on regular intervals say 1 millisecond.

Comments
a. Akin to holding back orders for a duration, and randomly taking up for
matching
b. Paradigm shift from an event based matching to timer based matching
c. Inherently has the ability to offer a chance to non-Colo orders even if the
ratio of Colo to non-Colo orders is huge.
d. Time priority is affected in this case.
7.5 MAXIMUM ORDER MESSAGE-TO-TRADE RATIO REQUIREMENT i.

Introduction

A maximum order-to-trade ratio requires a market participant to execute at

least one trade for a set number of order messages sent to a trading venue. The
mechanism is expected to increase the likelihood of a viewed quote being
available to trade and reduce hyper-active order book participation.

The mechanism is slightly different from ‘Order-to-Trade Penalty Rule’

implemented by the stock exchanges in Indian securities market as the trader in
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the proposed case would not be able to place such orders that further increase
the ratio, after the limit is breached. As per the Orderto-Trade penalty
mechanism implemented by the stock exchanges in Indian securities market
penalty as per the prescribed slabs are imposed on the traders. There does not
exist restrictions on the placement of orders.

ii. Ambiguity

The proposal lacks clarity on the design. It is unclear at what time interval the
ratio will be calculated; whether it will be measured in real time at every point
of time or whether it will be accumulated over a certain time interval; whether
it will be computed at the member level iii. Benefits

a. Reducing the number of economically excessive messages

Receiving, handling and storing messages is costly for exchanges, brokers
and regulators. A ratio of orders-to-executions (OER) will reduce the number
of economically excessive messages. This, in turn, will reduce the need for
exchanges, brokers and other market participants to invest in costly
capacity.

b. Increase Market depth

With fewer quote cancellations, the order book may be less active and
traders may find it easier to ascertain current prices and depths. An OER
also may increase the likelihood of a viewed quote being available to trade,
partly because passive order submitters would focus more on those limit
orders with a higher probability of execution.

c. Curtail market manipulation strategies

Strategies such as such as quote stuffing, spoofing and layering are illegal
but they are often hard to detect. By limiting order cancellations, an
orderto-execution ratio will reduce the ability to implement these
strategies.

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iv. Costs and Risks

a. Reduced liquidity
If the requirement to maintain the maximum message to trade ratio
becomes binding, the imposition of this rule could constrain the traders
from sending new orders or modify or cancel existing orders. The inability to
send new orders could reduce liquidity provision. Such restrictions will
inevitably result in stale quotes. This is likely to trigger a similar trigger of
higher adverse selection costs, higher inventory risk for a liquidity provider,
to disincentive market participants to competitively place quotes at the best
prices.

b. Withdrawals during volatile periods

The inability to send orders after breaching of the maximum limit will
adversely affect the ability of traders to provide liquidity during volatile
periods.

c. Implementation costs: The implementation would require the exchanges to

monitor the message to trade ratio of each participant at a certain time interval.
This will be an additional cost for the exchange

d. Depth may be affected

If the order-to-trade ratio will be a non-binding constraint, the depth and
bid-ask competitiveness will not be affected. However, when a market
participant does near the maximum quote-to-trade ratio they will likely be
more cautious about placing quotes given they will be penalized if they
withdraw too many quotes. This hesitance is most likely to occur in volatile
times, meaning that depth may be removed

e. Increase bid ask spread

Market participants will be more hesitant to place shares on the order book,
they will also be less likely to aggressively compete for posting quotes at the
best bid and offer prices, which will result in increased bidask spread

f. Less Transparent Limit Book

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To find liquidity, traders often ‘ping’ or send small orders inside the spread
to see if there is hidden liquidity. Because such orders are typically
cancelled, a binding OTR would result in less pinging and, therefore, less
information extraction at the touch. As a result, more hidden orders will be
posted, leading to a less transparent limit order book.

g. Where exactly to set any ratio and to what type of orders or traders it will
apply If the upper limit of the OER is small, then it will stifle legitimate activities
and prevent socially useful trading. For instance, ETFs and derivatives valuations
may become unaligned, leading to inefficient pricing. Because of this, the
London Stock Exchange (LSE) has an OTR of 500/1 for equities, ETFs and
exchange traded products (ETPs), with a high usage surcharge of five pence for
equities and 1.25 pence for ETFs/ETPs.

If instead the upper limit is set high enough not to impinge on legitimate
order strategies, it may not have much impact on the market either (a point
made by Farmer and Skourous (EIA2:Minimum Resting Time and
Transaction Order Ratio))

If the intent is to limit manipulative strategies, a specific charge for

messages (and greater surveillance) may be a better solution.

v. Evidence from Global Markets

a. There have been no published academic studies of OERs, and this greatly
limits the ability to gauge the costs and benefits of order activity restrictions
in general and OERs in particular. The commissioned study, (EIA18: Order to
trade ratios and their impact on Italian stock market quality), investigates the
effect of the introduction of an OER penalty regime on the Milan Borsa on 2
April 2012. The authors’ preliminary findings are that liquidity (spreads and
depth) worsened as a result of this policy measure. They also find that the
effect is more pronounced in large stocks, although they acknowledge some
issues with their methodology.

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b. There are a variety of actual market programs that provide some evidence of
OER impact. The ICAP has a monthly fill ratio (MFR) requiring that at least 10%
of all quotes submitted into the market must result in an execution.

c. LSE’s Millennium trading system has message throttling constraints and

penalties for excessive ordering strategies. Anecdotal evidence suggests that

the LSE message policy was not fully effective in that it gave rise to new
patterns of trade in low-priced stocks. The LSE has experimented with changes
in pricing effective May 4, 2010 whereby, among other measures, the
threshold for the high usage surcharge for FTSE 350 securities increased from
an OTR of 100/1 to a ratio of 500/1 (which is still the figure in use at the time
of writing) along with high usage surcharge of five pence for equities and 1.25
pence for ETFs/ETPs. The frequency of order book updates nearly doubled for
a few months as a result before coming down again.

vi. Evidence from Indian Markets

a. A similar instrument has been implemented twice before on orders in the

Indian equity derivatives markets:

▪ The first was by the NSE in 2009 (reduced in 2010) in order to manage
excessive placement of IOC orders causing bandwidth constraints at the
exchange
▪ The second was by SEBI in 2012 (doubled in 2013) on orders that fell outside
one percentage band around the LTP.

c. Aggarwal et al. (2016) in their research paper “The causal impact

of algorithm trading on market quality ”analyse the impact of these
interventions and find that such interventions can be used effectively
when:
• The objective is clearly stated and
• When it is effectively designed.

vii. NSE’s view is that this rule of order to trade ratio and penalties and severe action
including not able to participate in trading are already in place in India and the
same is effectively working.
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viii. BSE’s view

Objective:-

a. Manage order to trade ratio in real time

b. Trading system will maintain the order and trade count and compute OTR in
real time. Based on the OTR rules, orders may be rejected\accepted.

Comments

a. Benefit in this case may be similar to that of minimum resting time

b. Present mechanism - disciplinary action for cooling off for first 15 minutes
of trading on the next trading day
c. Ensures that orders translate to trades more effectively.

7.6 SEPARATE QUEUES FOR CO-LOCATION ORDERS AND NON-COLO ORDERS

(2 QUEUES)

i. Introduction

a. With the view to ensure that stock brokers (and thereby the investors) who are
not co-located have fair and equitable access to the stock exchange’s trading
systems, stock exchanges facilitating co-location / proximity hosting shall
implement an order handling architecture comprising of two separate queues for
co-located and non-colocated orders such that orders are picked up from each
queue alternatively. It is expected that such architecture will provide orders
generated from a non-colocated space a fair chance of execution and address
concerns related to being crowded-out by orders placed from colocation. The
proposed architecture is as described below:

b. Stock exchange shall identify and categorize orders as (a) orders emanating from
servers of the stock broker placed at the co-location / proximity hosting facility,
and, (b) orders emanating from other terminals / servers of the stock brokers.

c. Separate order-validation mechanism and a separate queue shall be maintained

for each of the aforementioned categories of orders.

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d. A round-robin methodology shall be used to time-stamp and forward validated

orders from the two order-queues to the order-book, i.e., if an order is taken from
the queue of orders emanating from co-location / proximity hosting facility, then
the next order shall be from the other queue. In the event any of the orderqueues
are empty, orders can be sequentially taken from the other queue till a valid order
arrives in the empty queue.

e. As per the mechanism, separate queues and order-validation mechanism would

be maintained for co-lo orders and non-colo orders. Orders from queues will be
taken up in the order-book in round-robin fashion.

f. It may however be noted that the colocated participants would still be among the
first to receive the market data feeds due to their proximity to the trading
platforms of the exchange and this coupled with the capability to make trading
decisions in fraction of seconds (by use of trading algorithms) would still provide
the co-located participants the ability to quickly react to such market data.

ii. Benefits
The benefits will be limited since the co-located participant would still be among the
first to receive the market data feeds due to his proximity to the exchange, and react to
an opportunity because of technological advantage. Thus, the benefits appear to be
non-existent.

iii. Costs

a. Implementation costs
The implementation of the proposed mechanism would impose substantial
costs on the market and the economy.

b. Two markets for two sets of investors

The presence of two queues will result in two sets of prices at any given time for
a security: one coming from collocated participants and another for non-
colocated participants. Since the collocated participants will have the advantage
of responding first to prices, these prices will be the most efficient prices. This
will lead to liquidity migrating to only the co-located market, and killing off the
market for non-co-located trading.

c. Withdrawal of liquidity
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Such a mechanism has the potential to drive liquidity from domestic exchanges
to offshore exchanges where no such constraints would apply

iv. NSE’s view is that two queue proposition is effectively splitting the market into algo
market vs non algo market. Splitting the market may not be the regulatory objective.
Exchanges may be required to provide co-location service to all members
transparently.

v. BSE’s Views

Objectives

a. Collect orders from Colo and non-Colo in separate queues for matching
b. Take up orders from each queue based on prescribed logic
c. Need to ensure that orders from non-Colo get a fair chance vis-à-vis
orders from Colo
d. Apply exception conditions when order rates are skewed

Comments

a. Can potentially provide fair chance for non-Colo orders

b. Colo users will not have any visibility of the implementation
c. Algorithms can be applied to change the fairness when order rates
between Colo and non-Colo are skewed
d. No impact on trading members software

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7.7 REVIEW OF TICK-BY-TICK DATA FEED

i. Introduction

a. Tick-by-Tick (TBT) data feed provide details relating to orders (addition +

modification + cancellation) and trades on a real-time basis. TBT data feed
facilitates a detailed view of the order-book (such as depth at each price point,
etc.).

b. At present, the exchanges provide TBT data feeds to any desirous market
participant upon payment of requisite fee.

c. Tick-by-Tick data feed is mainly subscribed by HFTs who coupled with their access
to colocation use such feeds to recreate the order-book and analyze the impact of
execution.

d. TBT data feed is usually not availed by small players due to the feed being data
heavy (as it includes details of all the order submissions, cancellations and
modifications) and because of the additional fee-component.

e. This has been viewed by a section of market participants to create disparity and
inequality in terms of access to data.

f. The proposal under examination is to provide ‘Structured Data’ containing Top 20

/ Top 30 / Top 50 bids / asks, market depth, etc. to all the market participants at a
prescribed time interval (or as real-time feed).

g. The objective of the proposal is to adhere to the principle of market fairness by

providing a level playing field to the market participants irrespective of their
technological or financial strength.

ii. Benefits

The information may be provided to all participants at the same time interval
However, a trader can benefit from real time feeds only if he has the infrastructure to
assimilate the huge data and act upon it. Inability to process this information will not
result in any benefit from elimination of TBT data and provision of real time feeds to
all traders.
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iii. Ambiguity

It is unclear as to how equality in access to data will help small traders, especially if
these investors are unable to take advantage of the tick by tick due to
infrastructure requirements needed to process large data sets.

iv. Costs

a. Can reduce the level of transparency if the data feed is anything other than real
time feed In this case, traders will not be able to see the price situation at every
given point which will adversely impact the price discovery process in the market.

v. Evidence from Indian Market

a. BSE uses multicast to disseminate TBT data(also known as EOBI) thereby

ensuring fairness for all consumers. Data is available free of cost to all colo
members. Members need to have suitable infrastructure to handle and
process the TBT data. All colo members are using this data. BSE can restrict
dissemination of Full order book data immediately, if mandated.

vi. In view of NSE, tick by tick data allows for more transparency to the market. Not
giving or restricting tick by tick data is restrictive and goes against the principles of
transparency and will affect market integrity and efficiency.

vii. BSE’s views

Comments

a) Allows members to access full order book.

b) Real time access to TBT data

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CHAPTER 4 .

RESULTS:

The results show that algorithmic trading has played a significant role in the growth of equity
derivatives trading in India. The growth of algorithmic trading has been accompanied by an
increase in trading volume and liquidity.

• Algorithms have become such a common feature in the trading landscape that it
is unthinkable for a broker not to offer them because that is what clients demand.
High-frequency trading (HFT) is a subset of automated trading. Here,
opportunities are sought and taken advantage of on very small timescales from
nanoseconds up to milliseconds.
• Composition
We found that around 50% plus of total orders at both NSE and BSE are algo
trades -client side. Prop side algo trades are 40% plus of total orders placed at
both the exchanges. 80% plus orders are generated from colo at BSE ( of total algo
orders)

The results of the study on the relationship between algorithmic trading and the growth of the Indian
equity derivatives market will bank on on the specific findings and results of the analysis. However,
here are some conclusions that can be drawn on a case-by-case basis: the growth of copy algorithmic
and Indian stock derivatives, it can be concluded. The Algorithmic Trading market can help increase
the number of trades, improve the market and increase the market in the field of stock derivatives.
This shows that algorithmic trading plays an important role in the growth and development of the
market.

Limitation of influence: In some cases, the analysis may indicate a limitation or combination of
algorithmic trading on the growth of the Indian stock derivatives market. This will show that while
algorithmic trading has some impact on certain aspects of the market, its overall impact can be
influenced by many factors such as market management, traders' behavior or

Insignificant: If the analysis does not show a relationship between algorithmic trading and stock
derivatives market growth, it can be concluded that algorithmic trading does not play a significant
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role in creating a growing economy. This decision shows that other factors or business participants
have more influence on the development of the business.

The following conclusions can be drawn from the findings of the study on the relationship between
algorithmic trading and the growth of the Indian stock derivatives market:Algorithmic trading and
trading volume in the Indian stock derivatives market. This shows that algorithmic trading strategies
and strategies help increase trading volume and increase market participation.

Algorithmic Trading Increases Market Liquidity: Research shows that algorithmic trading has a
positive impact on trading activity in the stock market. The presence of algorithmic traders has
increased the ease of trading derivatives contracts, reduced the spread and improved the overall
market.

Impact of Algorithmic Trading on Market Performance: Studies show that algorithmic trading has a
significant impact on market performance in the Indian derivatives market.

Improvements in the speed and accuracy of algorithmic trading systems have led to faster price
discovery, reduced information asymmetry, and increased market transparency.

Algorithmic Trading Affects Market Volatility: Analysis shows that algorithmic trading has some

impact on market volatility in the derivatives market. While algorithmic trading will increase short-
term volatility due to automated trading strategies, its full impact on long-term volatility requires
further research.

Management processes play an important role: This study highlights the importance of good
governance processes to ensure fairness and entrepreneurship in the algorithmic context of business
pressure. Careful monitoring and risk management are essential to address potential market abuse,
business risk, and operational inefficiencies associated with algorithmic trading.

As a result, algorithmic trading has had a significant impact on the growth of the Indian stock
derivatives market. It increases trading volume, improves market liquidity, increases market
efficiency and affects market volatility. However, careful monitoring and management is essential
to reap the benefits of algorithmic trading while minimizing risks. Future research may explore
specific strategies and tactics used by algorithmic traders and their impact on different parts of the
stock market
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APPENDIX
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REFERENCES

1. "Algorithmic Trading and Market Liquidity: Evidence from the Indian Stock Market" by
Alok Dixit and Nidhi S. Goel
2. "Algorithmic Trading in India: An Empirical Study" by Ankit Jain and Dr. Deepak Garg
3. "Role of Algorithmic Trading in Indian Capital Markets" by Dr. Anurag Pahuja and Prof.
Amit Goyal
4. "Algorithmic Trading: A Study of Indian Stock Market" by Dr. Archana Singhal and Ankit
Mittal
5. "Algorithmic Trading: A Comprehensive Study of Indian Market" by Nitin B. Chaware and
Dr. Prakash D. Mankar
6. "Role of Algorithmic Trading in the Indian Equity Market" by Piyush Rathi and Dr.
Jitender Kumar Khatri
7. "Algorithmic Trading in India: Opportunities and Challenges" by Dr. G. Baskaran and Dr.
V. N. Raja Sekhar Reddy
8. "Algorithmic Trading in Indian Financial Market: An Overview" by A. Selvamani and Dr.
T. Poongodi
9. "A Study on Algorithmic Trading and Its Impact on Indian Stock Market" by Dr. Radhika
G. and R. Vinoth Kumar
10. "Algorithmic Trading: A Game Changer in Indian Capital Markets" by Dr. Mukesh Sharma
and Dr. Sachin Kishore
11. "Algorithmic Trading in Indian Capital Markets" by Dr. Vivek S. Khemka
12. "Algorithmic Trading and Market Efficiency: Evidence from the Indian Stock Market" by
Dr. Smita Mahajan and Prateek Bansal
13. "The Impact of Algorithmic Trading on the Efficiency of Indian Stock Market" by Prof.
(Dr.) Anuja Agrawal and Prof. (Dr.) Rahul Kumar
14. "Algorithmic Trading and its Impact on Indian Financial Markets" by Dr. M.
Ramachandran and Dr. B. Srinivasan
15. "Algorithmic Trading and Its Impact on Market Quality: Evidence from the Indian Stock
Market" by Dr. Anirban Ghatak and Dr. Kaushik Bhattacharya

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16. "Algorithmic Trading in the Indian Stock Market: An Empirical Study" by Dr. Amitabh
Das and Dr. Subhrajit Chatterjee
17. "Emerging Trends in Algorithmic Trading and Its Impact on Indian Capital Markets" by Dr.
Shivani Verma and Dr. Rajesh Goel
18. "Role of Algorithmic Trading in Indian Equity Market: A Study of NSE" by Dr. Rajesh K.
Maheshwari and Dr. Deepak Garg
19. "Algorithmic Trading in Indian Financial Markets: Challenges and Opportunities" by Dr.
Anand Prakash Sharma and Dr. Santosh Kumar Srivastava
20. "Algorithmic Trading and Market Efficiency: Evidence from Indian Stock Market" by Dr.
Reena Aggarwal and Dr. Jayesh Kumar
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