Algorithmic Trading: Expanding Access to Retail Investors and Regulatory Supervision

India’s stock market trails its roots back to the colonial period when the East India Company introduced share, bonds and concept of exchanging tangible commodities. The Bombay Stock Exchange and National Stock Exchange commonly addressed as BSE and NSE respectively were instituted in the 19th and 20th centuries. Stock trading earlier involved verbal negotiations with the brokers, and share certificates were paper – based, which were always burdened with the risk of misplacement and forgery. With passing of time, the market emerged to include telephonic communications, and the introduction of Dematerialization accounts in 1996 facilitated electronic trading, expediating market transparency. SEBI introduced Direct Market Access (DMA) in 2008 for institutional investors. Algorithmic trading has gained prominence, leveraging automated software for data-driven and rapid execution of trades.[1] SEBI has now through a Circular dated February 4, 2025, bearing no. SEBI/HO/MIRSD/MIRSD-PoD/P/CIR/2025/0000013 introduced additional measures to strengthen Algorithm Trading which is mainly to safeguard Retail Investors from the evils of Algo Trading but also to facilitate to them, access to benefits of Algo Trading through registered brokers and Stock Exchanges.

Algorithmic trading (“Algo Trading”) intermingles computer programming with financial markets to automate trade execution, reducing human error and optimizing the timing of trades. High-frequency trading (“HFT”), a core component of algo trading, entails executing numerous trades using pre-programmed instructions across multiple markets. Systematic traders like hedge funds as well as institutional investors such as Pension funds and Mutual funds, commonly use algorithmic trading to accumulate large stock positions without affecting market prices. Trend-following, Arbitrage, and Index Rebalancing are some of the key strategies included in algorithmic trading. Application Programming Interfaces (APIs) enable impeccable interaction with exchanges, serving real-time data and locking competent execution. Lucrative engagement in algorithmic trading demands aptitude for coding, network access and knowledge of trading market, which together foster efficiency and liquidity for institutional players.

Developments in technology and the availability of user-friendly platforms have made algo trading more available to retail investors. Accessible only to institutional traders previously, enhanced tools are now at the disposal of retail traders, allowing and easing for them to execute complex strategies with minimal capital and technical expertise.[2] Press releases from SEBI in September 2024 projected the growing participation of retail investors, with 54% of IPO shares allotted to them being sold within a week. An impressive number of 144 IPOs between April 2021 and December 2023 showed that retail investors have significantly contributed to liquidity, especially in the derivatives segment.[3] The number of retail traders has almost doubled by FY24. Despite their growing presence, retail traders, particularly in the equity F&O segment, face considerable losses compared to institutional investors who benefit from algorithmic strategies.

In light of this, SEBI implemented regulatory measures to safeguard participation of retail investors.[4] SEBI released a consultation paper in December 2021 aiming to address the risks related to algorithmic trading and propose various measures. These included mandate for brokers to ensure that third-party algorithms used by retail investors are approved by exchanges.[5] The guidelines introduced in 2022 also prevented and prohibited brokers from associating with unauthorized platforms which offered speculative returns. The contributions aim to regulate algorithmic trading, protect investors and stabilize market integrity.

The new regulatory framework, which will take effect on August 1, 2025, establishes clear guidelines for retail participation in algorithmic trading. Brokers must act as principals, using APIs from fintech vendors or algorithmic providers to execute trades. Each order must be tagged with a unique exchange identifier, and retail investors must register their algorithms with the exchange if they exceed certain thresholds. These algorithms are restricted to personal use by the investor and their immediate family members. Brokers must ensure their systems detect algorithmic orders, block open APIs, and maintain secure access through authentication protocols. Additionally, brokers must obtain exchange approval for algorithms, monitor trading activities, and address investor complaints. While algorithmic providers are not directly regulated by SEBI, they must be empanelled with exchanges to ensure supervision over the Algo Providers. Brokers must conduct due diligence before onboarding algorithmic providers and disclose all fees transparently. Algorithms are classified as Execution Algos (White Box), which are transparent and replicable, and Black Box Algos, which are non-replicable and undisclosed. Black Box Algos require registration as a Research Analyst, the submission of a research report, and re-registration if their logic changes.

While algorithmic trading caters several benefits, including speedy order execution, diminished transaction costs, price optimization, and the elimination of human error, it also presents dispenses consequential risks which can lead to complex disputes involving issues of technology, which may not be in the competence of the traditional methods of dispute resolution and which may require specialists in the field of this technology to give evidence. This may also make the dispute resolution more expensive and unviable for many retail investors. The absence of human interference and judgment in real-time decision-making can lead to accidental repercussions. Algorithmic trading can also augment market volatility, especially during intervals of high-frequency trading, shooting up the possibilities of market instability. Furthermore, the notable investment required to conserve the requisite technology and infrastructure, coupled with increased regulatory scrutiny, makes algorithmic trading a complex and potentially risky practice.

Numerous high-profile events have enhanced the risks of algorithmic trading.[6] In 2015, allegations floated that the traders exploited NSE’s Trading Access Point software, executing large volumes of trades that disadvantaged competing brokers. As a result, NSE was fined by SEBI to the tune of ₹1,000 crore in 2019 for projecting failure in maintaining the track of fair access to its co-location facility.[7] However, in September 2024, the charges of market manipulation were dismissed by SEBI due to insufficient evidence.[8] Similarly, in 2022, SEBI cleared a broking firm of charges related to multi-legged algorithmic trades, deducing that no violations had taken place. The Flash Crash that occurred on BSE Muhurat Session in 2011 and the 2012 Flash Crash on Nifty April futures are some of the previous episodes which underline the potential for significant market instability and financial losses caused by distorted algorithmic trades.[9]

The expansion of algorithmic trading to retail investors presents significant opportunities to enhance market participation, but it would be futile if observant regulation, supervision and implementation is absent at any stage. The regulatory framework of SEBI undoubtedly offers essential safety measures, but its efficacy will depend on execution in the right direction and continuous monitoring. As algo trading becomes more accessible, the industry must without any failure strike a balance between remodelling and risk management to shield the retail investors from financial and operational debacles, both predicted and unforeseeable. The triumph of this regulatory framework in long run will depend on warranting market transparency and curtailing technological and legal risks. Ongoing surveillance and adaptability in regulatory practices will be significant in maintaining reliance of the investors and shielding market stability.

We hope you have found this information useful. For any queries/clarifications please write to us at insights@elp-in.com  or write to our authors:

Ashishchandra Rao, Partner, Email – ashishchandrarao@elp-in.com

Ria Rastogi, Advocate – Email – riarastogi@elp-in.com

[1] SEBI Circular bearing no. SEBI/HO/MIRSD/MIRSD-PoD/P/CIR/2025/0000013 dated February 04, 2025 – “Safer participation of retail investors in Algorithmic trading” available at https://www.sebi.gov.in/legal/circulars/feb-2025/safer-participation-of-retail-investors-in-algorithmic-trading_91614.html

[2] Press Release by SEBI bearing reference no. 19/2024  dated September 02, 2024 – “SEBI study shows 54% of IPO Shares allotted to Investors (excluding anchor investors) are sold within a week”  available at https://www.sebi.gov.in/media-and-notifications/press-releases/sep-2024/sebi-study-shows-54-of-ipo-shares-allotted-to-investors-excluding-anchor-investors-are-sold-within-a-week_86387.html

[3] Press Release by SEBI bearing reference no. 22/2024 dated September 23, 2024 – “Updated SEBI Study Reveals 93% of Individual Traders Incurred Losses in Equity F&O between FY22 and FY24; Aggregate Losses Exceed ₹ 1.8 Lakh Crores Over Three Years” available at https://www.sebi.gov.in/media-and-notifications/press-releases/sep-2024/updated-sebi-study-reveals-93-of-individual-traders-incurred-losses-in-equity-fando-between-fy22-and-fy24-aggregate-losses-exceed-1-8-lakh-crores-over-three-years_86906.html

[4] Consultation Paper on Algorithmic Trading by Retail Investors dated December 09, 2021 available at https://www.sebi.gov.in/reports-and-statistics/reports/dec-2021/consultation-paper-on-algorithmic-trading-by-retail-investors_54515.html

[5]   SEBI Circular bearing no. SEBI/HO/MIRSD/DOP/P/CIR/2022/117 dated September 02, 2024 – “Performance/return claimed   by   unregulated   platforms   offering algorithmic strategies for trading” – https://www.sebi.gov.in/legal/circulars/sep-2022/performance-return-claimed-by-unregulated-platforms-offering-algorithmic-strategies-for-trading_62628.html

[6] SEBI Order bearing reference no. WTM/GM/EFD/03/2018-19  dated April 30, 2019 available at https://www.sebi.gov.in/enforcement/orders/apr-2019/order-in-the-matter-of-nse-colocation_42880.html

[7] SEBI Order bearing reference no.  dated September 02, 2024 available at https://www.sebi.gov.in/enforcement/orders/sep-2024/order-in-the-matter-of-nse-and-others-co-location-_86674.html

[8]  SEBI Adjudication Order bearing reference no. Order/BM/UR/2022-23/20643-20647 dated October 21, 2022 – https://www.sebi.gov.in/enforcement/orders/oct-2022/adjudication-order-in-the-matter-of-bank-of-baroda-in-respect-of-5-entities_64288.html

[9] NIFM Research Programme  – A Study on Algorithm Trading/ High Frequency Trading in the Indian Capital Market, available at  https://www.ajnifm.ac.in/sites/default/files/uploadfiles/Compendium.pdf