These seem to be good days for program trading in India.The Securities and Exchange Board of India (Sebi) announced on Thursday that it would allow large institutional investors to buy and sell stocks directly, without any manual intervention by their brokers. This new system of direct market access is likely to help investors who trade using complex mathematical models. Many of these traders try to benefit from tiny changes in prices that are detected by their models. They need to grab the opportunity that flashes on their screens in a matter of seconds. Bypassing the broker will help them a great deal.
There have been other bits of news on this front as well. Lotus India Mutual Fund launched India’s first quant fund in November 2007. Reliance Mutual Fund has recently decided to convert one of its index funds into a quant fund. Funds house Benchmark, too, has applied to the regulator to start a quant fund that will trade on the basis of a mathematical model. And, Renaissance Technologies, a global hedge fund that is an algorithmic trader, has got permission to invest in India.
Program trading has had its ups and downs. It is widely believed that traders who bought and sold through software programs were responsible for pushing the US stock market off a cliff in the Black Monday crash of 1987. The collapse of hedge fund Long- Term Capital Management (LTCM) in 1998 was a case of models that did not work. Many quant funds have been singed in the recent global credit market turmoil. Mint has argued before in these columns that mathematical models based on historical correlations have their inherent limitations. A blind belief in models is a form of conceit.
Yet, the recent activity in quant investing should be welcomed, since it will enrich the financial markets here with greater variety and provide investors with more choice. The broader issues of systemic risk will continue to be relevant. Quant traders tend to work with huge leverage, and they have occasionally paved the way to larger financial crises because of this.
But, these are early days — and man will continue to dominate model in India for many years.
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