Retail investor Beware Algo traders are active in the market By Dr. Bobby Srinivasan and Dr. Sudhakar Balachandran

September 15, 2015 | Posted by bobbysrinivasan << back to blog

The recent turbulence in the global stock markets was not only a reminder of the ever growing importance of China’s economy but also is a testimony to how computers dominate the workings of the stock exchanges. The Monday morning (24 August 2015) collapse of the global stock market with the Sensex opening with a drop of over 1000 points is the result of algo trading. Algo trading comprises high frequency trading strategies which are developed by software companies and implemented. So when the first sell signal is generated, the computer engages in big time short-selling pushing the markets to ridiculous levels.

It is really not so much that algorithms are used to trade but the retail investors remain so uninformed that the market movement catches them by surprise. To protect what is left, they rush to sell their portfolio booking big losses. Many of the mutual fund’s net asset value dropped extensively. It is all a scary experience.

In the last one year our market has dropped several times over 600-700 points in a single day. On those days the market stayed volatile and this is primarily due to algorithmic trading. In the US stock market investors learnt a big lesson in 2010 due to flash crash which was the result of algo trading. To make it more transparent NYSE introduces new circuit breakers. By this method the stock market closes its activity temporarily to ward off the panic. Even with this measure the mutual and the exchange traded funds swing so bizarrely that there were no prices available for the underlying stocks.

The result is that the policy maker and the investors are in a bind. Nobody wants to get rid of algo trading but then what. The scary situation is that going forward retail investor is likely loose so much in the market because of this immense price fluctuation. There are no easy solutions. In the past banks smoothed trading flows by fulfilling the rule of a market maker. But they have partly withdrawn from the role due to a regulatory squeeze. And nobody seems eager enough to kick computer generated trading programs out of the market. Since in normal times they appear to provide the liquidity that banks no longer offer, without high frequency traders it would probe be more costly for investors of all sizes to trade.

Retail investors, be warned. This market gyration will challenge your confidence and faith in the market. There is a high probability that their portfolio value may drop 40 to 50% in a single day. The question is whether the retail investor will survive the volatility. In summary the Indian stock market is not suited to weak hearted persons.

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