What Is Algo Trading in India? Explained Step by Step

Do you remember the first time you watched a price chart or a candlestick chart closely? Not casually, but with intent! You might have seen a continuously moving candlestick chart, moving up and down with longer and shorter candlesticks following one another. As you look at the chart, you realise that markets move in patterns, and rules can define these patterns.

This simple realisation is the beginning of your journey toward algo trading.

In recent years, India’s markets have transformed from bustling trading halls to quiet server rooms running millions of instructions per second. Retail investors can now access tools that were previously limited to large institutions.

A SEBI study from September 2024 states that “the profits were generated by larger entities that used trading algorithms, with 97% of FPI profits and 96% of proprietary trader profits coming from algorithmic trading.” (SEBI)

In this blog, we will discuss what is algo trading, how does it work, benefits, how it is different from manual trading and much more. Let’s quickly dive in and talk more about it.

What Is Algo Trading?

Simply, trading with computer programmes that rely on the use of algorithms (pre-defined rules or instructions) for order execution is called algo trading. It can effectively remove human intervention from the execution phase of trading. A successful system is designed to rely on three core components: Strategy, Market Data and Automated Execution Engine.

1. Strategy: The brain of any algo trading operation is strategy. Strategy defines the logic where you define rules. Your logic could be technical indicator-based, price-action driven, or a hybrid of both. For example, if price breaks a level, retests it, and forms a rejection candle, you can execute a long trade.

2. Market Data: Market data becomes the eyes in algo trading. It is used to provide the required inputs or instruction. It requires accurate price, volume, and timing information to make decisions.

3. Automated Execution Engine: The hand that places the trade is an automated execution engine. It sends orders to the exchange through a Trade API, ensuring seamless operation.

These three components work together to identify and make the most of market opportunities. Now let’s understand how it works.

How Does Algo Trading Work?

Algo trading systems use sophisticated computer programmes for automatic trade execution. The operational workflow of algorithmic trading follows a logical and structured sequence. You must know how it works:

1. Choose a Strategy and Define Trading Rules: To begin the algo trading process, select a specific strategy. You must first translate the strategy into code, defining precise entry and exit points.

2. Import Real-Time Market Data: The system then connects to a data feed. Thus, the system can monitor asset prices and volumes in real time.

The algorithm will then implement the following steps:

3. Algorithm Identifies Opportunity: The computer programme continuously scans the incoming data. It will look for conditions that match the predefined trading rules.

4. Automated System Executes Orders - After the algorithm has spotted a valid opportunity, it generates a signal. The system would immediately send buy or sell orders to the exchange without human delay.

5. Risk Controls Applied - Advanced algorithms can simultaneously apply risk checks, ensuring the order size remains within limits and the stop-loss parameters are in place.

The last step highlights your role in managing algo trading performance.

6. Monitoring and optimisation - You can monitor the system's performance and with continuous refinement, ensure that the logic remains effective in changing market conditions.

Benefits of Algo Trading

The process of algo trading flows from you to the algorithm and back to you. However, even as it begins with you as the trader, it considerably reduces human error instances.

There are various benefits associated with automation over traditional manual methods.

1. High-Speed Execution: With computers, you can process information and execute trades in milliseconds. You can use this speed to capture opportunities that humans would miss.
   
2. Eliminates Emotional Decision-Making: Fear and greed are the major factors leading to poor trading decisions. Since algorithms adhere strictly to the plan, they ensure trading discipline.
   
3. Consistency and Rule-Based Discipline: Consistency is one of the most valuable features of algo trading. The system is capable of executing the strategy exactly as programmed every time.
   
4. Ability to Trade Multiple Markets at Once - An algorithm can scan and trade hundreds of stocks or multiple asset classes at once.
   
5. Reduced Manual Errors - Automated entry can eliminate the risk of "fat-finger" errors, such as entering the wrong price or quantity.
   

Thus, algo trading can considerably reduce human errors in trading. However, the success of any algo trading strategy depends on the strength of the strategy and the adoption of dynamic market conditions.

You have understood the nitty-gritty of algo trading, but how do you get hands-on experience? Let’s find out in our next section.

How to Start Algo Trading in India

Traders can start with building rule-based strategies and gradually refine them. Starting the algo trading journey requires a systematic approach.

Choose or Design a Strategy: Begin by identifying a trading concept that can align with your risk appetite and financial goals.

Deploy Live with Capital: Once the system proves stable, you can connect it to a live brokerage account using a Trade API and allocate capital.

Track and Refine Performance: The market conditions are dynamic, so you should regularly review performance reports and tweak the algorithm to maintain profitability.

Risks and Challenges

There are many automation benefits available for traders. However, you must know that this automation can also introduce specific risks.

1. Internet / Platform Failure: A loss of internet connectivity or a broker-side outage can leave positions open without management.
2. Over-optimisation: This is known as curve-fitting. Creating algo trading strategy that fits historical data too perfectly often leads to failure in the live market.
3. Volatility Shocks: Sudden market crashes or extreme volatility can trigger unexpected behaviour in algorithms.
4. Leverage Risks: Automated systems can execute positions rapidly. If leverage is managed poorly, losses can accumulate considerably and quickly.

Risk Mitigation Tips for Algo Trading

Risks in algo trading can lead even the most perfect strategies to failure. Thus, effective risk management is the foundation of successful algo trading.

Here are three useful strategies to protect your capital.

1. Use Stop-Loss Automation: You should never rely on mental stop-losses. Automated systems can execute exits faster than any human reaction. With hard-coded stop-loss implementation, orders ensure that a position is automatically closed once it hits a predetermined loss level. Thus, you can prevent a single bad trade from spiralling into a catastrophic loss. This strategy especially works during flash crashes or periods of extreme volatility.

2. Start Small, Scale Gradually: Resisting the urge to deploy all your capital at once is the core of any risk management planning. You can begin with a small position size, representing a negligible fraction of their portfolio.

3. Avoid Over-Fitting Strategies: An algorithm tuned too finely to past market noise rather than genuine trends can result in over-fitting. You can mitigate this risk by keeping the strategy logic simple and robust. You can also validate models using out-of-sample data (data the model has not seen before) to ensure its adaptiveness to new and unseen market scenarios.

SEBI Regulations for Algo Trading

The SEBI has established a comprehensive framework to ensure the algorithmic trading ecosystem’s integrity. These regulations are designed to protect retail investors and maintain market stability.

1. Oversight Under SEBI Framework: The regulator has mandated that all algo strategies be approved by stock exchanges before deployment. This is a vetting process to ensure that algorithms do not pose a risk to the market's orderly functioning. Also, all algo orders are to be tagged with a unique identifier for precise audit trails and accountability.

2. Role of Brokers and APIs: Brokers are responsible for client algorithms’ audit and approval, ensuring built-in risk checks, such as order limits and margin validation for the APIs. To prevent unauthorised use, the use of open APIs is restricted, and access is typically granted only through secured and static IP addresses.

3. Compliance is Key: Adherence to these norms is mandatory for all retail traders. There are severe penalties for using unapproved algorithms or bypassing broker controls.

Such regulatory compliance is important to ensure a level playing field. They protect individual traders from the risks associated with unregulated and high-frequency trading practices.

Future of Algo Trading in India

The future of algorithmic trading in India seems robust with the right combination of strategy, risk management and compliance. But there is still space to explore and evolve in algo trading.

• AI-powered models will likely introduce adaptive learning capabilities, allowing systems to evolve in real-time.
  
• Cloud-based execution will further reduce latency and hardware dependency for all retail traders.
  
• High retail and institutional adoption might drive market liquidity and innovation in the future.
  

With the above, trade API testing environments and execution speeds can likely improve, making the field even more competitive.

Conclusion

Your journey begins with understanding the market through structure, levels, and disciplined entries. Algo trading simply takes that same clarity and scales it with greater speed, accuracy, and consistency.

However, in this domain, success requires a solid understanding of market mechanics and strict adherence to risk management. You can leverage a robust Trade API and follow regulatory guidelines to navigate the complexities of the Indian market with confidence.

Sources:

SEBI
Business-Standard
ET
globaltrading
SEBI Official