Govt study favours harmonised surveillance for algo trading

New Delhi: Stock exchanges need to harmonise surveillance mechanism and invest in advance technologies to keep a tab on high frequency trades, which can even be used to manipulate markets, says a government study.

High frequency trading (HFT) or algorithmic trading refers to use of programmes and computers to execute large orders in markets electronically.

The study by the Department of Economic Affairs and National Institute of Financial Management (DEA-NIFM) Research Programme comes at a time when there are persisting concerns over possible misuse of algorithmic trading popularly known as algo trading.

Generally, orders for algo trades come from institutional investors, funds and trading desks of big banks and brokers.

According to the 128-page study, both NSE and BSE have its own methods and levels of sophistication to manage surveillance of algo trades.

"However, in our view harmonisation of surveillance mechanism would bring about uniformity in exchange action towards harmful HFT," it said.

The study further said there is a definite need to invest in advanced technology to automatically detect harmful HFT and market manipulative trends/algorithms. Exchanges hardly have advanced mechanisms to detect harmful HFT.

Algo trading reduces transaction costs.

"We found that around 50 percent plus of total orders at both NSE and BSE are algo trades -client side. Prop side algo trades are 40 percent plus of total orders placed at both the exchanges. 80 percent plus orders are generated from collocation at BSE (of total algo orders)," it said.

As per the DEA-NIFM study, it has been proved in the past that algo trading and HFT can be used to manipulate markets using techniques like quote stuffing, layering (spoofing) and momentum ignition.

"Evidence suggests that because of quote stuffing stocks experience decreased liquidity, higher trading costs, and increased short term volatility... Momentum ignition events can result in massive price moves backed by false volume," it said.

Markets regulator Sebi is already looking into alleged preferential access given to some brokers through NSE collocation facilities, while the exchange is looking to settle the matter through consent mechanism.