Order-based surveillance measure: A move to checkmate persistent noise creators

We have recently seen a lot of positive development in terms of compliance and regulatory framework by Securities & Exchange Board of India (SEBI). For example, clarity on the margin framework for F&O and cash segments, etc with the recent being order-based surveillance measure.   

Although this comes a month after NSE outage, which has no direct relation to this circular, but SEBI has made all attempts to strengthen the financial ecosystem from time to time. SEBI’s order-based surveillance system, which is slated to be implemented from April 05, 2021, is expected to be quite effective to curb what is known as ‘noise’ by the Regulator. The proposed measures are likely to help the retail trader against the ‘noise’ that is created by the high-frequency traders, who use Algorithms to place, bid/ask.  

Using complex algorithms, high-frequency traders (HFTs) have been practically preventing a retail trader to place a legitimate ‘limit’ order by out-bidding or out-asking the limit price placed by the retail trader. This practically disallows the retail traders' right to put a limited order. The Algorithms of HFTs often manage to reduce the priority of such limit orders placed by the retail segment.   

Milan Vaishnav, CMT, MSTA, Consulting Technical Analyst & Founder of Gemstone Equity Research & Advisory Services, explains it with an example.   

We have observed that in over half of F&O segment stocks, Futures, and also in options, whenever a retail trader places a bid, he will instantly see another bid placed above his bid, usually with a gap of 0.05 paise or by some margin. This means that if a retail trader places a limit order to buy an option or Futures at Rs 100, he will immediately see a bid placed at Rs 100.05 on top of it. This bid is generated by HFTs Algorithms, aimed simply at preventing the retail trader's bid to get executed.  

A similar thing happens when a limit sell order is placed. For example, if a retail trader places a sell order, at say, Rs 100, he will immediately see another sell order, typically lower by 0.05 paise. In this case, Rs 99.95 will be placed. This again is generated by HFTs Algorithms aimed simply at preventing the retail trader's offer to get executed.  

He further expressed that whenever a trader cancels his bid/ask, he will also see another order going away as well. As a result, retail trader is prevented from placing a limit order and consequently, he has no option to either buy at the best offer price or sell at the best bid price.  

Milan believes that the proposed measures are likely to deter such unethical practices of the HFTs. However, even if it is widely feared, it is NOT likely to have any adverse impact on the retail segment. On the contrary, it is expected to help them by addressing the menace of the HFTs and putting a check on their unethical practices.  

Vishal Mehta, CMT, a systematic trader and Founder of www.marketscanner.in shares his views on: Who will be impacted the most and who won’t be as well as for whom this was being done?   

Who will be impacted the most?  

There were traders who used Algo to price deep-in-the-money options and try to benefit from any mispricing of the instrument, which required constant change in the bid/ask as the market keeps on moving.  Many times, their order was through Algo, which constantly changed and added the load to NSE servers.    

Who will not be impacted?   

Retail traders mostly use market orders or limit orders to place their buy and sell. The only concern was modifying the stop-loss. Many discount brokers have also put limitations on their API for not allowing constant modification of the orders.  For example, we are running a system based on ‘Supertrend indicator’, which requires adjusting your trailing stop-loss with the change in the value of Supertrend coming in your favour. Now currently, we handle by cancelling that stop-loss order and putting a new one after a few attempts.   

For whom this was being done?   

Although we cannot confirm for India; globally, we have seen and heard cases of market spoofing & layering. That means they create artificial demand or supply clogging the bid/ask, which are not only executable but also, creating an environment of panic. This will definitely help to reduce the same if it all was happening in the Indian markets.  

The new measure shall be applicable on the daily trading activity at the client/proprietary account level in a security/contract and shall be based on the following three parameters: high order-to-trade ratio, high instance/number of order modification and a high percentage of the order modifications leading to a persistent deferred/lower order execution priority. The instance identified based on the aforesaid three conditions will be considered ‘one instant count’. Based on the count of instances over a period of rolling 20 trading days, Exchanges will determine the penalty.   

If the instant count exceeds 99 on a rolling 20-trading day basis, it will result in trading disablement of such a client/proprietary account for a time period of first 15 minutes of trading and the disablement shall be carried out on the next trading day. Any additional instance of repetitive violation on consecutive trading days by a client/proprietary account on a rolling 20 trading days basis will lead to trading disablement for a period of ‘N’ instance * 15 minutes, subject to a maximum disablement of 2 hours (i.e., N <=8).  

The first surveillance action on such persistent noise creators shall be on May 5, 2021 based on the 20-trading day window.