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1 *Corresponding author: [email protected]
2 †Corresponding author: [email protected]
2
Ring Trading to Algo Trading—A Paradigm Shift Made Possible by Artificial Intelligence
Aditi R. Khandelwal
IIS Deemed to be University, Jaipur, India
Abstract
This chapter explains a framework which shows the transformations which took place in Indian stock markets and their working. Several year’s back the stock exchanges were physical places bussing with people and where everything used to happen manually by humans. The trades were executed by a process referred to as open outcry. Clients had to wait till the next day to see the high low prices of shares in the newspaper. The participation in stock market was low and selective.
Then came the time when a boom in stock market came and people at large started investing with the coming up of brokers cum investor like Harshad Mehta but sadly now we remember him as a fraud. The stock market also saw a change in the working of exchanges. Systems started becoming computerized and one fine day everything shifted to internet-computer based systems called online trading. The latest scenario is where highly sophisticated computer based programmes called as Algorithmic trades came into force. These are trades which are totally human less and thus help in normalizing the trading, too high or too low is detected and stopped by auto cut off modes.
Keywords: Stock market, ring trading, open outcry, settlement cycle, depository, algorithmic trade, stock exchange
2.1 Introduction
Stock markets are the nerves of an economy and industry of any country. They are the intermediaries who move the savings from households into the main stream industry on one hand and on the other makes a common man part owner of big companies of the country and the world. Since the inception of stock markets which dates back to 1875 when “Native Share and Stock Broker’s Association”, India’s first share trading association was formed which later came to be known as Bombay Stock Exchange (BSE). It was created with just 318 members. Since then, stock exchanges and trading have gone through a lot of changes. If we see the broadest bifurcation of stock market generations, then it can be broken down into three major generations. The first was the era of ring trading, followed by the transformation period from ring trading to online trading based on sentiments and run by major few, and the latest which is even more neutral and runs on artificial intelligence (AI) algorithms.
2.2 Ring Trading
Traditionally, rather I should say historically trading in the stock market used to happen in the trading ring which was physical areas in stock exchanges where the stock brokers used to stand and trade stock by open outcry. To understand it better, a ring is a location on the floor of a stock exchange where trades were executed in old times before internet came in our lives. Few renowned brokers used to enter the ring and shout out the orders placed by their clients; these were then sent to the record keeper of trades who would also keep a track of lowest and highest prices of each stock. Since the whole process used to be done manually, there was less efficiency and a lot of confusion as well [1].
2.3 Features of Generation 1: Ring Trading
1 1. Complete Human Interaction: Back in the days of ring trading, no technology was used and the whole system worked manually. There were no computers to store the data, no internet to circulate the information to the places, so everything was managed by a few people who were closely associated with the stock markets of that time.
2 2. Low Volume: Since a lot of information flow and also awareness about the businesses and their stock was not there, so stock trading did not used to happen at grass root level. It was only limited to a few people who knew big business houses or their associates or the ones who had good financial background who were approached by the brokers.
3 3. Less Transparency: Since there was no centralization and everything used to happen with hand by a few people, also with less information flow, the mechanism was not very transparent [4]. Clients had to trust the brokers for information and also regarding the prices of the shares they traded in.
4 4. No Authenticated Trade Verification: If we compare it with current times when at the end of every day broker has to confirm the trade personally to the client and which is also intimated to him by SEBI and his DP at the times of ring trading, then no such authentication used to take place at broker and client end which at many times resulted in defaults.
5 5. Physical Exchange of Share Certificates and Money: Share certificates existed in physical form in hard copy, had to be sealed with company stamp, and had to be posted from one owner to another in case of a trade. Same was the case with money; it actually changed hands between clients, brokers, stock exchanges, etc. [2]. So, the whole process was very lengthy and time taking which also resulted in loss and theft of share certificates and money.
6 6. Localized Functioning of Exchanges: There were a lot of stock exchanges; literally, at all centers of trade, otherwise people of that city could not trade efficiently. Companies had to be listed on each stock exchange to create volume and presence at all places. It all gave rise to complexities and also gave way for scams and frauds.
7 7. No Participation of Tiers II & III and Rural India: Since information flow was very less, so people in smaller cities and towns had no idea about the working of stock exchanges. They either thought of it as a place of making big money or a hoax to lose money. So, the actual participation was not there by the people of smaller places.
8 8. Long Trading Cycles: Today, a trade squares up in T+2 days that means that with 3 working days after a trade has been executed, the seller gets the money in his account and shares from his DP are transferred to the buyers account, and at buyers end, he gets the
