As SEBI cracks down on F&O, brokers eye algo-trading as new revenue stream

The Securities and Exchange Board of India's (SEBI) new rules on algorithmic trading for retail investors are set to create a new way for brokers to make money. With stricter regulations on F&O trading—one of their biggest revenue sources—brokers are now looking to cash in on algo trading instead.

The new framework for algo-trading will take effect from August 1 this year.

Algo-trading encourages more frequent buying and selling, which can translate into higher earnings for brokers, said Trivesh D, chief operating officer at Tradejini. He said that with a fee of Rs 20 per trade, an increase in trading activity through algos naturally increases broker revenues.

"In the next three to six months, we expect more clarity on regulations for algo trading platforms and once the rules are in place, platforms like Streak could grow significantly," said Harsha M, Founder & CEO of Streak funded by Rainmatter (by Zerodha).

He added that in the next two to three years, algo trading could become a game changer, and Streak may even modify its revenue model based on user adoption. But this depends on how many people are actually interested in following trading based on predefined rules , he said

"Currently, HDFC Securities offer open APIs and once we observe how the market evolves we do plan to collaborate with partners to offer trading strategies," said Ashish Rathi, whole-time director at HDFC Securities.

He said that it is a win-win situation for brokers — for the ones who have not ventured deeply into algo trading -- it is an opportunity to start. And for those already involved — it allows them to regularize their operations.

A retail investor can access algo-trading in two ways. One, he can go on a do-it-yourself (DIY) platform and create investment strategies. Two, he can use an existing investment strategy offered by a broker or a fintech company. The strategy however, will have to be pre-approved by the exchanges before the company offers it.

Also read Brokers welcome algo-norms, but will wait for clarity before investing big

How does a DIY platform work?

Retail traders can use DIY platforms where they can create and test trading strategies without the need to code.

"Users can create trading strategies using technical indicators like EMA,SMA, RSI, math functions, and others without writing any code. Users can back-test their strategies on historical market data to see how the strategy has performed over the years. When deployed in the market, the platform sends a notification with an order window and after the condition is met, the user must manually approve the trade for execution," said Harsha, explaining how Streak works.Drawbacks

With the new circular, open APIs might no longer be relevant since every strategy, whether self-developed or through partnerships beyond the threshold limit which ISF will finalise would require exchange approval, said Rathi. He however added that the time taken for strategy approvals will need to be watched.

The final circular for algo-trading said that exchanges shall specify the turnaround time (TAT) to register certain types of algos like execution algos on a fast-track basis while registering other types of algos on a normal basis.

Each algo-strategy has a scalability limit due to market volume constraints. For example, if many people are using the same strategy, the returns of that particular strategy will reduce. This is similar to AMCs capping fund inflows when they reach a point where additional investments could dilute returns.

In the algo space, scalability will require multiple strategies running in parallel to manage order execution effectively, said Trivesh.

"When a strategy reaches its threshold, additional investments are restricted. To manage this, leading algo firms run multiple strategies to minimize slippages and ensure scalability," Trivesh said.

In a DIY platform there is higher flexibility for users as they are creating their own strategy, said Harsha. He added that users can build millions of unique strategies and with discipline the chances of profitability for retail traders increases a bit.Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.