Zerodha CEO Nithin Kamath busts myths around algo trading returns

There is a misconception that algo trading generates guaranteed returns, Zerodha founder and chief executive Nithin Kamath said on Tuesday.

"Finding strategies that trade more frequently to seem profitable isn't hard. But in almost all cases, the high returns drop sharply or even vanish once you account for impact costs and trading costs," says the CEO of India's largest discount brokerage.

This comes days after the Securities and Exchange Board of India (SEBI) cautioned investors against unregulated platforms offering algorithmic trading services or strategies.

"Some unregulated platforms are offering algorithmic trading services/strategies to investors for automated execution of trades. Such services and strategies are being marketed with claims of high returns on investment. Further, 'ratings' have been assigned to the strategies, which could lead to investors being lured by such claims," the market regulator said in its circular on September 2.

Stock brokers who provide services relating to algorithmic trading shall not directly or indirectly make any reference to the past or expected future performance of the algorithm, the order said.

Commenting on SEBI's circular in a Twitter thread, Kamath says some of these platforms have built utilities using broker APIs or macros when APIs aren't available to automate order placements for their users and claim to be partners.

"We have been reaching out to all these platforms, asking them to remove our names from their website," says the Zerodha CEO. "I am guessing SEBI is asking this because it is easy for these platforms to sell greed by showing extraordinary backtested returns to lure customers."

"An algo strategy is only as good as the person who creates it. The same person who's influenced by fear, greed, & other biases. Also, we all know that past returns don't guarantee future performance or results," Kamath says.

Even when there are real historical returns, like in the case of mutual funds, SEBI insists on various risk disclosures. The fact that these algo platforms could claim whatever without any disclosures was a loophole that is now plugged, he adds.

Kamath, however, hopes that the circular expected on the use of APIs and algos post the discussion paper from the last year doesn't block out or make it extremely hard for retail customers with programming knowledge using APIs for personal use, becoming collateral damage.

As per the latest SEBI guidelines, stock brokers who are directly or indirectly referring to any past or expected future return of an algorithm or are associated with any platform providing such reference, shall remove the same from their website and disassociate themselves from the platforms providing such references.

The market watchdog also called on the stock exchanges to take necessary steps and put in place the necessary systems and procedures for the implementation of these provisions.