Algo Trading for Retail Traders: SEBI’s New Circular and Its Implications

On February 4, 2025, a significant development took place in the Indian trading landscape. The Securities and Exchange Board of India (SEBI) released a circular announcing that, from August 1, 2025, retail traders will be allowed to place their orders through algo trading. However, this development comes with a set of complexities, responsibilities, and regulatory measures that need to be understood by all stakeholders, including exchange brokers, algo providers, and traders.

A Brief History of Algo Trading Regulations

Algo trading has been a subject of discussion since March 30, 2012, when SEBI released its first paper on the subject. That document provided broad guidelines but lacked concrete regulations, penalties, or even the mention of retail traders. Over the years, multiple consultation papers and small circulars have been issued, but the circular of February 4, 2025, marks the first significant step towards formalizing algo trading for retail investors.

The Timeline and Responsibilities

• April 1, 2025: Exchange brokers must have their Standard Operating Procedures (SOPs) in place.
• August 1, 2025: Algo trading provisions for retail traders will be formally opened.

Understanding Algo Trading According to SEBI

SEBI defines algo trading as any automated execution of orders without manual intervention. These trades occur based on pre-programmed instructions, eliminating the need for human execution of buy/sell orders.

Types of Algo Trading Software

API-Based Algo Trading

• Brokers provide an Application Programming Interface (API) to external algo software, allowing automated order execution.
• The broker must ensure that each trade has a unique identification and that all API-based trades are monitored.
• Retail traders developing their own algo strategies may be exempt from exchange approval if their trade execution frequency remains within predefined limits.

Categorization of Algo Software

• White Box Algos: Open-source execution logic where transparency is maintained.
• Black Box Algos: Proprietary execution logic where the code is not disclosed.
• Black box algo providers must obtain a license from SEBI and seek fresh approval for any modifications.

Responsibilities of Stakeholders

For Brokers

• Must categorize and track algo orders exceeding the specified limits.
• Cannot allow unrestricted API access to third-party software.
• Must implement two-factor authentication for API-based algo trading.
• Are responsible for due diligence and background verification of algo providers.
• Are accountable for any violations or complaints arising from their partnered algo trading software.

Algo Trading Legal in India

• Must set up processes, SOPs, and guidelines for algo software empanelment.
• Will oversee confidentiality measures, non-disclosure agreements, and encryption protocols for retail algo strategies.
• However, the exchange has not been assigned direct accountability in case of compliance failures.

Potential Challenges and Future Considerations

• Black Market of Algo Providers: Unregistered algo software remains a concern, and there is no clear plan on how to tackle unauthorized algo providers.
• Retail Trader Awareness: SEBI must ensure that traders are well-informed about regulatory requirements to avoid falling prey to unregistered algo trading platforms.
• Implementation of Due Diligence: The specifics of due diligence for algo providers are yet to be defined. If left ambiguous, brokers might arbitrarily approve or reject algo software.

Conclusion

The SEBI circular on algo trading marks a pivotal shift in India’s trading ecosystem. It provides opportunities for retail traders to automate trades while holding brokers and algo providers accountable. However, challenges such as black-market algo providers, trader education, and enforcement of due diligence measures need further clarification. As we move closer to April 1, 2025, and eventually August 1, 2025, more details and amendments will likely emerge.