Algorithmic trading and the NSE equity markets: Has the market changed for the better?

Nidhi Aggarwal and Susan Thomas

The implementation of co-location in securities markets world-wide has caused wide-spread concerns among regulators globally about whether different sets of traders have different access to markets. Further, policy makers are concerned that when there is such a variation in access, the quality of markets will decrease on average. In this policy paper, we examine this question in detail, by summarising the work done on testing this proposition in global exchanges, and quantitatively analysing the proposition in the Indian equity market at NSE. The NSE provides data that helps to identify the answer to these questions in a unique manner where every order is tagged by whether it has been generated by an algorithm and where every trade indicates whether an algorithmic trader was a buyer or a seller. In the paper, we find that the Indian equity markets are increasingly becoming dominated by algorithmic trading; that this has not prevented the non-algorithmic trader from being able to generate a large number of trades (and therefore participate in the price discovery process); that algorithmic traders do not flee the market when there is market stress with the Emkay Crash being a case study; and that market quality of stocks where there is greater algorithmic trading intensimproves compared to stocks that algorithmic traders do not prefer to trade. Given that higher algorithmic trading is better for the overall market, policy research needs to next focus on how to ensure that there is more algorithmic trading focus more uniformly across all stocks in the market compared to a subset of the stocks.

Citation: Algorithmic trading and the NSE equity markets: Has the market changed for the better?, Nidhi Aggarwal, Susan Thomas. FRG working paper series, January 2015.