Topic of the Day – Black Box Trading

UPSC Exam Preparation: Topic of the Day – Black Box Trading

Black Box trading is a term generally used for automated trading systems. It is also called Algorithmic Trading or Algo Trading. Advanced and complex mathematical models, as well as formulas, are made use of, in the trading systems to make quick decisions and transactions of high speed in the financial markets.

  • Black Box Trading is based on utilizing fast computer programs and complex algorithms in order to create and determine trading strategies with the view to optimize the returns.
  • Algo trading is a means to reduce the costs, make market impact while reducing the risks involved in the execution of an order. It is not an attempt to make a trading profit.
  • Institutional traders that are involved in the execution of huge orders in the markets but are unable to support all the size at once i.e, hedge funds, mutual funds, pension funds and investment banks widely make use of Black Box trading.

 

Why does Algo trading need to be regulated?

  • In order to minimize instances of misuse of automated trading systems.
  • There have been instances of flash crashes that have happened overseas.
  • India has also seen instances of flash crashes a few times, could be minimized.

 

Steps taken in the past:

  • India is one of the very few countries in the world which has mechanism for controlling the misuse of algo trading. Securities Exchange Board of India (SEBI) provided for high order to trade ratio penalty system. This penalty would be enhanced further

 

Background:

  • Many countries and regulators, including the International Organization of Securities Commissions (IOSCO), have been debating on this issue for many years, only India had been able to come out with proper regulations in algo trading.

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