SEBI expresses apprehension regarding algo developers enticing unsuspecting traders with unrealistic returns while evading SEBI regulations governing registered investment advisors (RIA) as mandated. The issue of misselling also poses a significant challenge.
In a recent development, market regulator SEBI proposed that brokers should grant access to open Application Programming Interfaces (APIs) to retail clients only if they are aware of whether the API is utilized for algo trades or manual trades. If the broker is unable to ascertain this, access to the API should not be provided to the client.
SEBI is proposing that brokers only provide open APIs to clients when they can confirm whether the API is used for algo or non-algo trades. This measure aims to ensure brokers are aware of the API usage and its purpose, fostering transparency.
This approach helps brokers collaborate with developers who are transparent about their algos, gradually bringing algo developers under SEBI’s oversight. Consequently, this move is expected to significantly reduce misselling. Additionally, SEBI suggests that backtesting results should be endorsed by an independent performance validation agency rather than the algo developers themselves, offering a more accurate assessment of strategy effectiveness.
Internationally, in April 2016, the US SEC approved a FINRA rule requiring algorithmic trading developers to register as securities traders to combat market manipulation. In the UK, market participants must notify the Financial Conduct Authority if they engage in algo trading, providing details of their strategies and trading parameters.
Regarding retail traders coding their strategies, it’s likely they’ll need to inform brokers about their algo strategies, similar to institutional requirements. The major criticism against third-party algo providers is that widely known strategies lose effectiveness, and skeptics question why they’d share potentially lucrative strategies for minimal returns.
Algo trading’s suitability for retail investors depends on the strategy. While some may succeed, most retail traders struggle against quant firms investing heavily in talent and technology. As speed is crucial, sophisticated infrastructure like co-location server facilities is often necessary for success in algo trading.