SEBI proposed Retail Algo Trading Framework

Recent Context

1. In February 2025, The Securities and Exchange Board of India (SEBI) allowed participation of retail investors in Algorithmic trading.
2. Earlier, only institutional investors were allowed to use it via Direct Market Access (DMA)
   1. Direct market access (DMA) is a way of trading financial instruments directly on an exchange, without using a third-party broker.   
3. In this regard, SEBI also put out a framework to regulate the participation of retail investors in the algorithmic trading space.

What is Algo trading?

1. Algorithmic trading (or algo trading) is trading using automated execution logic.
2. Here, computers are programmed using pre-set rules to automatically buy and sell stocks.
3. Thus, instead of a human clicking “buy” or “sell”, a computer program executes trades at high speeds.
4. Two main strategies in Algo trading:
   1. Low-frequency strategies
      1. To make a few trades over hours or days
      2. For example, Trend-following algos may buy/sell when the market reaches a certain level.
   2. High-frequency strategies
      1. To execute several thousands of trades per millisecond
      2. For example, Market-making algos constantly place buy and sell orders, profiting from tiny price differences.

Advantages of Algo Trading

ADVANTAGE	DESCRIPTION
Speed	Executes trades at high speeds, much faster than human traders, taking advantage of market opportunities in milliseconds.
Accuracy	Minimizes the likelihood of human errors in placing trades.
Market Monitoring	Continuously monitors multiple markets and securities, identifying and seizing opportunities instantly.
Emotion-Free Trading	Eliminates emotional and psychological factors from trading decisions, relying solely on logic and rules.
Back testing	Allow traders to test strategies using historical data to forecast how they would perform in real market conditions.

What are the key highlights of the Regulatory Framework?

1. Role of brokers:
   1. Retail investors will get access to the approved algos only from the registered brokers.
   2. Sole responsibility of brokers in handling investor grievances.
2. Trading Limits for Retail Traders:
   1. Retail traders must follow exchange-set limits (yet to be decided).
   2. Registration of algos developed by retail investors if they cross the specified order per second threshold.
3. Registration of Algo Providers:
   1. Algo providers are not regulated by SEBI but must register with exchanges and partner with a broker to sell algos.
4. Categorization of Algorithms:
   1. White box: Logic is disclosed and replicable i.e. Execution Algos.
      1. They must be registered with the exchanges once and can be offered to any trader once registered.
   2. Black box: Algos where the logic is not known to the user and is not replicable
      1. To offer them the algo provider will have to get a Research Analyst (RA) license from SEBI and meet certain compliances.
5. Unique identifier:
   1. Each algo order would be tagged with a unique identifier to establish an audit trail.
6. Responsibility of stock exchanges:
   1. Supervision of algo trading
   2. Establishing comprehensive Standard Operating Procedure (SOP) for testing of algos.
   3. Surveillance on all algo orders and monitoring their behaviour at all times.

Key market-related terms

TERM	DEFINITION
Retail investor	Nonprofessional investor who buys and sells securities for their own personal use
Institutional investor	Organization that pools money to invest in securities, real estate, and other assets
Stockbroker	Financial professional who buys and sells stocks as per clients' direction. For example, Zerodha, Groww etc.
Algo providers	Businesses that sell algorithmic trading strategies and programs to traders
Stock exchange	Exchange where stockbrokers and traders can buy and sell securities. For example, BSE

 

What is SEBI?

 

 

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