A decade ago, the demise of the open outcry system shifted action from noisy trading floors of stock exchanges to air conditioned dealing rooms of brokerages. Today stock trading is in the throes of the next big change.
Professional day traders, hired by brokerage houses on a profit sharing basis, are slowly losing out to pre-written software codes, which does the same functions at a speed that is humanly impossible. Instead of providing office infrastructure to a dozen ‘jobbers’ (as day traders are known in market parlance), a brokerage can now do with two CDs containing pre-written trading strategies, and two people to oversee the execution.
Not only does it save costs for the brokerage firm, but also improves the chances of making profits, as software codes are faster and efficient than the most skilled of traders. In short, software codes will battle each other for a share of rapidly thinning intra-day trading profits.
This spells serious consequences for the 20-25,000 strong force of professional day traders who speculate in equities. Even veteran traders are dismayed at this emerging trend, as it robs them the fun of matching their wits against those of rival market participants.
Instead, they are now locked in a unequal battle with software programmes, that can spot an arbitrage opportunity and cash in on it even before the traders can press the keys on their trading terminals.
“There has been an increased acceptance of trading software over the last year, as traders are struggling to generate decent returns in the face of volatile market conditions,” says Shubham Pradhan, marketing head at Essex India, a firm that offers trading software.
Indeed, algorithm trading, which involves pre-written software codes identifying and executing arbitrage opportunities at lightning speeds has been at the centre of controversy in a few developed markets, as regulators and a section of investors have raised ethical questions.
But in India, they are fast catching on, as many brokers are gradually reconciling to the fact that even the most skilled of their traders will never be able to match the speed of execution of a software program.
One of the common arbitrage strategies is to sell stock futures quoting at a premium to spot, and buy the shares, thus locking in the difference. Another common strategy is to sell shares on the exchange where the prices are higher, and simultaneously buy them back on the exchange where the prices are lower, or the other way round. But the spread has to be such so as to be able to make a meaningful profit, and a trader should be able to seize on the opportunity as soon as it shows up, because they barely last for a second for a second or two.
Here is where a program can execute the trade faster than a human being. “But you also need sophisticated hardware and a good network to get the maximum benefit out of these software programmes,” said Pradhan who thinks brokerages will cut back on the number of in-house jobbers as well as those hired on a profit sharing basis.
But not everybody shares that view. “Algorithm trading is fast catching on. But there may not be any mass lay-offs at brokerage houses,” says Hitesh Hakani, director, Greeksoft, which claims to have sold 1000 licenses so far. “The broking house can certainly save on costs as the time required to train their staff on these trading programmes will be shorter. Also, you will not need highly skilled jobbers, as is the case with manual trading,” he says.
Market watchers say many of the high-end trading software are not yet on offer for two reasons. One, the stock exchanges trading systems have to be more efficient to for these programmes to deliver optimum results. Two, the software vendors have to run their codes through the stock exchanges for approval, and some fear that proprietary trading strategies could be leaked.
"Trade volume relative to our overall base is still quite small. Volumes are less than 1% of our daily traded volume; but I would expect this number to increase sharply towards the end of the year. To date we have more than 20 clients live and trading actively in India," said Brook Teeter, director - equities
, Credit Suisse, which recently launched a suite of algorithmic strategies broadly termed Advanced Execution Services.
He feels “the ability for the machine to work out the varying nuances of the market at very high speed is a determining factor for success.”
But there are some who fear that the proliferation of algorithm trading could make the market a more difficult place. “Jobbers are a key link in the chain of players that form the stock market ecosystem,” says a BSE broker.
“Unlike software codes that are designed purely to capture momentary arbitrage opportunities, jobbers have open positions at any given point of time, even if in small quantities. This adds to the liquidity in the market, thus providing a cushion against a sudden move in share prices, on either side. Drive the jobbers away, and you will only add to the volatility,” he says.
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