Why in News?

•  Sebi finds National Stock Exchange of India Ltd (NSE)guilty of lapses in algo trade case.

What is Algorithm?

•  It is a set of instructions which a computer is programmed to follow in order to carry out a particular task.
•  In the case of trading, advanced mathematical tools are used for facilitating transaction and decision making in the financial market, the need for a human trader’s intervention is minimized and thus the decision making is very quick.
•  This enables the system to take advantage of any profit making opportunities arising in the market much before a human trader can even spot them.
•  The common trading strategies used in algo-trading are:

High Frequency Trading (HFT):

•  It involves placing a large number of trade orders across multiple markets and decision parameters at a very high speed, based on preprogrammed instructions.

Trend Following Strategies:

•  It follow trends in moving averages, channel breakouts, price level movements and related technical indicators.
•  A lot of proven mathematical models, like the delta-neutral trading strategy, which allow trading on combination of options and its underlying security, where trades are placed to offset positive and negative deltas so that the portfolio delta is maintained at zero.

Trading Range (Mean Reversion):

•  It is based on the idea that the high and low prices of an asset are a temporary phenomenon that revert to their mean value periodically.
  Identifying and defining a price range and implementing algorithm based on that allows trades to be placed automatically when price of asset breaks in and out of its defined range.

Volume Weighted Average Price (VWAP):

•  This strategy breaks up a large order and releases dynamically determined smaller chunks of the order to the market using stock specific historical volume profiles.

Time Weighted Average Price (TWAP):

•  It breaks up a large order and releases dynamically determined smaller chunks of the order to the market using evenly divided time slots between a start and end time.

Implementation Shortfall:

•  It aims at minimizing the execution cost of an order by trading off the real-time market, thereby saving on the cost of the order and benefiting from the opportunity cost of delayed execution.
•  The strategy will increase the targeted participation rate when the stock price moves favorably and decrease it when the stock price moves adversely.