Understanding Net vs Gross

We are often bedazzled by the profit screenshots of full time traders on the social media. Even seemingly unknown traders appear to be making 5-10k every day. You might wonder if you can achieve same level of profits. And that is the key. Profits. The money left after paying for all the expenses.

If you have a source of income other than trading, it might already be covering all of your expenses. In that case, every single rupee you make from trading is your profit. Now consider someone who is making 10k every day from trading. She makes a handsome 2L gross profit per month. But from that she has to pay for all her expenses. And I am not talking about food and electricity. It includes, brokerage, transaction charges, taxes, data feeds etc. So her net income might be a lot less than the screenshot that is posted on the social media.

So if you ever consider going full time in the markets, please account for the loss of a consistent income from your other source. The pressure of ‘needing to make money’ is tremendous for the new full time traders and you will feel that. Because a trade doesn’t just remain a trade. It becomes ‘gas bill’, ‘movie night’, ‘rent’ and so on. And even the best of the traders admit to having some bad months where they make very subpar profit or even incur losses.

So next time you a screenshot with a large profit, take all this into account.

Time is small

brass pocket watches

So I recently accepted a job. Hence the extended absence from the blog. Pretty much whole of the first month went into complaining how hectic this job was, and how I had practically no time to do anything else. Then one day I had to travel with my manager from one site to another. Being coordinator of a large region, he was almost constantly on the phone. Interesting part was that pretty much every single minute he wasn’t on an office call or replying to a work mail, he was on a video call with his daughters. I don’t think he ever got to talk to them for 10 minutes continuously. But a two or three such opportunities during a three hour journey would be enough to refresh his mind.

And then it struck me. If instead of thinking of this journey as one chunk of time of 2 hours, if I thought of it as 24 slots of 5 minutes each, I suddenly seem to have a lot of time. Here are some of the things I could do in one or two slots each:

  1. Check several charts for positional trades.
  2. Read an interesting blog post.
  3. Watch a relaxing video on YT.
  4. Think about a blog post (!)
  5. Write a blog post.
  6. Study a small topic for CFA.

The list will grow as I remember more and more things that I am supposed to do. And granted, not everything can be achieved this way. Playing an instrument comes to mind as an example. But there are other times when we have such slots but we barely utilize them since we do not think of our time at that granular level. Once you train your mind to notice such slots, you will see them everywhere.

And I understand that there is no replacement for long periods of focused work, but when your day ends at 9 in the evening and all you want to do is crash on the bed and submit yourself to sleep, you will have to get your other activities done this way.

Swing trading in particular is for suitable for people like me who have very little time to monitor the positions. All I can do is see the charts once in a while and find out the supports or demand zones. Then simply putting GTT orders at suitable prices would get the job done.

Trading options this way is possible too. But hedging will be the order of the day and one would have to be ready to accept max loss since you may not be able to adjust the position in time if the market moves against you. I recommend sticking to index options only since those are more liquid than the stock options and can be safely exited on a market order. Index options are cash settled as well so positions will be automatically settled upon expiry. Not the case with stock options which will be physically settled. Read You dont know what you dont know for more such things to look after while trading.

Practically everything in life can be gained again except time. So why while it away? Use it as much as you can…

What is the ideal size?

person in black pants holding yellow ruler

Apparently professional traders are often asked about the minimum account size one must have to trade in futures. There’s a long answer and a short answer for this. You can find the short answer on twitter somewhere so I will walk you through the long one.

Lets say there are 10 stocks you trade very regularly. You have also done backtesting of your strategy to figure out the idea stop loss that is required.

StockLot SizeCMPStop Loss (%)Stop Loss (Rs)Stop Loss/lot
RELIANCE5051945358.3529,500
HDFC30021953.576.82523,000
HDFCBANK550140045630,800
TCS300270025416,200
INFY60011002.527.516,500
ONGC770080.5021.6112,400
ITC320019447.7624,832
HINDUNILIVR3002125242.512,750
BANKNIFTY252915051457.536,438
NIFTY75128352.5320.87524,066
I have rounded off some numbers for ease of calculations. Lot sizes change over time, so double check the sizes you use from NSE website before calculation.

Stock, Lot size ,and Current Market Price (CMP) are the data columns. Stop loss percentage comes from your backtesting. Then per share loss is simply multiplication of CMP and Stop Loss (%). For example, for RELIANCE, 1945*0.03 = 58.35/- rs per share. Since one lot of RELIANCE is made up of 505 shares. You will lose 505*58.35 = 29,500/- rs per lot.

So let’s look at the maximum loss by amount in the last column of the table. Thanks about 36,500 rs for Banknifty. We will use this for our risk calculations.

Now comes the next question. How much money as a percentage of your capital can you risk per trade? If your answer is 1%, then 35,000 should correspond to 1% of your capital. That comes to 36,50,000 or 36.5 Lakhs.

Let me illustrate why the textbook answer of “About 15-20L is enough to trade in futures” is harmful for your trading journey. Let us say you jump in with 15L to trade in futures. If you are still willing to risk only 1% per trade, you can only take a loss of up to 15,000/-. So if you spotted a trade in Banknifty, you would be forced to either take the trade with half of your normal stop loss or break your rules and take more risk per trade than you have initially decided. If you keep half of the normal stop loss, the accuracy may reduce. If you take more risk per trade then your account can drawdown more than you had anticipated.

In my personal opinion one should only use futures when one wants to take a short position in a scrip. If you want to go long, you can simply buy the stock. You get the freedom of position sizing. You can add more if you want, you can book your partial profits at first target, you get benefits of corporate actions while you are holding the stock, etc.

I know that indices, currencies and commodities are only traded in futures. But the same risk management principles apply there as well.

Take the same approach we Indians take while packing food for the trip. We usually pack enough for us, our co passengers, the conductor, the driver, the cute dog we see at the rest stop and some more for the return journey. Have enough margin in your account before getting into futures so that even if your every single trade goes wrong in the first month, you can still trade once the calendar turns.

Happy trading…

Understand the purpose

colorful cutouts of the word purpose

Everything you do in in the markets must have a purpose. And no, I don’t mean it in the philosophical sense.

If you are investing in mutual funds, usual purpose is to meet future financial goals. If you are trading, you are trying to profit off of market inefficiencies.

No matter what instrument you use, making money is your end goal. If you can make it without ever touching futures, options and intraday trading, how does it matter? Attempts to catch bottoms to buy or tops to sell are done for bragging rights more than making money. You could have caught bottom of Coal India at Rs. 110 mid-October and be up about 10%. Someone who simply bought Kotak Mahindra Bank on the same day because it looked like it would resume its uptrend would be 45% up today. Catching bottom means nothing if you can’t make money from it.

Understand the purpose of FnO as well. One of which is the leverage. You can trade in several hundred shares while paying for only a part of them upfront. Another one is expressing market views which can’t be expressed in any other way. For example, extended sideways movement can be cashed in effectively by option selling. Shorting can’t be done in cash market, and hence must be done using futures or options. Decide instruments based on your strategy and not the other way around.

Make perfectly clear to yourself why you are in the markets. If it is to sound smart by saying words like Iron Condor, long unwinding, head and shoulders, there are a million other ways of sounding smart without risking your capital. If you are in it to make money, take the simplest route available to you. There are no points for taking a tough path and failing.

What are you selling exactly?

woman in yellow shirt sitting on brown wooden folding chair on beach

This post is in some way related to my previous post, The face down card on social media. This is also going to be a very brief post since it is written and scheduled in advance, in anticipation of my other engagements at the time.

When you listen to Warren Buffet, you will realize how voracious of a reader he is. He devours reports after reports on companies, sectors, economies and pretty much everything he finds interesting. And this has been his work ethic for all of his professional life.

If you talk to any of the serious trader/investors, you will realize how much of their time outside of the market hours is taken up by ‘home work’. They too check the charts, shortlist stocks, review trades, read reports and so on. So when you see social media of such traders you will often see posts about earnings commentary, analyzed charts, thoughts from other investors/traders, etc.

There is another type of trader/investors. And in my very frank opinion these are the drug lords of the stock market. They post pictures from their yacht trips, luxury cars and lavish mansions. Every alternate post is about their ‘holy grail strategy’ that has made them multimillionaires at the age where people are barely thinking of buying their first bike. These posts will never show them working. They will always be on the beach in Bali or Caribbean, sipping pina coladas, supposedly trading and living their dream life.

A drug dealer never smokes what he sells. People I mentioned above, never implement their own tips. Their sole source of income is the ‘subscription’ they take from people like us, guaranteeing to provide riches.

I am not saying all such services are bad. But before you sign up for one, think about what exactly that person is selling you. Is it the mirage of money or an honest effort at creating wealth from securities.

P.S. – Many such tipsters are selling tips on forex and crypto markets. It is illegal to trade in non INR denominated trades in India. USDINR, EURINR are allowed, but EURUSD is not. Coincidentally it is the highest traded currency pair in the world and favorite of tipsters. Regulations around crypto trading are still very unclear in India. If you care about your capital at all, I would suggest you to keep it at an arm’s length till a reputed Indian broker offers crypto trading.

Practicing targets

abstract accuracy accurate aim

If there’s one thing we see consistently across all self help books, it’s setting goals. They talk obsessively about setting goals and breaking them down into sub goals and sub sub goals and planning every hour of your day….

Some goals require that kind of dedication and hard work. But some goals require work with carefully selected targets. Much like a company sets sales targets for its employee to reach the goal of profitability, we need to set ourselves some targets to reach our goal of consistency in trading.

As I wrote previously in my blog post, we must focus on what we can control and hence the targets that we set ourselves must be aligned to the same philosophy.

Most traders set targets for profit, or return on capital. I realized I wasn’t walking the talk. Market doesn’t owe me my target. I can’t force the market to give me the returns I expect or want.

Target setting varies from system to system. An intraday trader can reasonable expect to take several trades in a week. For her it might be statistically correct to check the PnL at the end of the month. For a swing trader there could be months where she doesn’t close any traders and PnL will be zero. Or a month could force her to book 3 losses in that month while several trades end in good profit the next. In such cases, monthly PnL isn’t a right measure.

Setting unrealistic targets can mess with your psychology too. If it looks like you won’t meet your weekly target, which you shouldn’t have set to begin with, you might force the trades and give up any gains that you might have made so far.

Also if you have multiple streams of income, you can set a collective quarterly target across all. I would consider trading in Equities, currency and commodities as three separate streams since required fundamental understanding of markets is quiet different in all three.

So set the targets you can achieve realistically with the capital you have. Follow prudent risk management and work on a trading system that gives you consistent market beating risk adjusted returns.

Happy Trading…

P.S. – Due to some personal reasons I will not be able to publish a post for two weeks.

You dont know what you dont know

white beads on question mark sign

Let me start with example. There is a internet message board called reddit. Communities on it are call subreddits. Among thousands of communities on gaming, cooking, landscaping and other activities, there is one for traders. And I use that word very loosely here. It is called WallStreetBets. Started as a genuine community for traders to share their research, it slowly evolved into a degenerate cacophony of gamblers trying to use derivatives market in america to place all-or-nothing type of bets. One such user was called 1r0nyman. He did some research and found out that there is an options strategy called Box Spread.

Here’s how a box spread works. You enter a bull call spread and enter a bear put spread in such a way that the bought call and sold put are of the same strike price and the bought put and the sold call are at the same strike price. In short, you enter into a long synthetic future at one strike price and enter into a short synthetic future into another. Here’s an example:

You can see in the payoff diagram that no matter where the Nifty moves the profit will be 203. Such strategies are called arbitrage strategies where traders try take advantage of market inefficiencies. But for retail traders the profit is not even enough to cover the cost of the trade. If you trade with a discount broker like Zerodha, you are charged 20 rs per order. Then it could only be economical if you could enter into at least 10 such spreads at a time so make something post charges. Also for 10 spreads you will need about 4 lac of margin. That makes roughly 2000 rs return a half a percent return for the trouble. There are some other problems as well. If you do not enter at the exact prices the arbitrage will not exist. Nifty lot size is 75, which means if you miss entries by as little 2.6 rs there wont be any arbitrage. Only large institutions and HFTs do this since this strategy is only efficient when done with automated systems.

Our trader buddy 1r0nyman had only seen the payoff diagrams. He figured that options on the SPY ETF which is comparable to our NIFTYBEES would work for this trade. He did the calculations and proclaimed that this trade literally can’t go t*ts up because money at risk is zero. Now here’s the catch. In India we trade in European style of options. That’s what the E in CE and PE stands for. European style of options can not be exercised before expiry. There is another flavor of options though called American options. These options can be exercised any time the buyer of options feels like. Now since we are short two options, one call and one put, one of them will always be in the money. Meaning there will always be the risk of one of those two options being exercised and us being forced to either give delivery of or take delivery of the underlying. Box spread is only profitable if held till expiry. But as soon as 1r0nyman entered into his trade, which was several times his account, people started exercising the options. He lost about $60,000 on an account of just $5,000. His broker realized what had happened and immediately closed 1r0nyman’s account. But sometime between getting into the trade and broker force closing the account, 1r0nyman had taken $12,000 worth of profit out from trading account into his bank account. So though his account showed a loss of $60,000, 1r0nyman made over 100% profit before closure. The loss was borne by his broker since 1r0nyman wasn’t supposed to be able to take that much leverage in the first place. Since then that broker has banned box spreads from their platform.

So what’s the lesson here? 1r0nyman didn’t know how bad his trade can go. But what is worse is his broker didn’t know about such catastrophic strategies. That is why it is important to remember that you will not know what you don’t know until the time something like this happens.

In India MCX didn’t know what happens when price of Crude is forced below zero in the international market. On MCX all futures contracts are physically settled. So if you hold a long contract of futures of Crude, you will have to take delivery of 100 barrels of oil. If you hold a long contract of Gold you will have to take delivery of 1 Kg of gold. Yes you read the units right.

Futures contracts on NSE are cash settled on a day to day basis. If you had 10L margin but zero cash in your account, you could enter into a future long in Nifty. About 1.3L of margin will be blocked. Let’s say unfortunately Nifty closes 100 points down and your account shows an MTM loss of 7500 rupees. At the end of the day exchange expects you to pay that 7500 loss in cash. Margin will not work there. So despite having over 8L of margin in your account your broker will raise a margin call against your account. You didn’t know that you don’t know about cash settlement. But you will have to come up with that money somehow.

‘I didn’t know’ excuse doesn’t work in stock market. As a market participant you are expected to do your own due diligence.

So be aware, be prepared, and happy trading.

The face down card on social media

playing game card

Have you ever sat through an Multi-level-marketing / pyramid scheme pitch? The person trying to get you on board spends a lot of time on convincing you how this is the best ‘business’ decision of your life. They show you charts and figures of how with a little work you can make 5% per month and when you upgrade to the pro-elite membership you will make about 15% and the people you bring on will make money for you and so on. They make it sound like a business better than selling tea outside a government office. Their motivation is simple; to get you on board and get the commission.

Many insurance and mutual fund distributors specifically push the schemes which pay them highest commissions rather than the one that is best suited for their clients. A car mechanic ‘finds’ several ‘critical’ problems in your car while doing ‘regular’ maintenance. An optician convinces you of how in this age of work from home you need lenses which cost 10 times the regular ones to ‘protect your eyes’. Stock brokers ‘train’ their clients to use leverage and trade in intraday and FnO.

Each of these ‘experts’ put their interest in front of their clients’. It is a good idea to have your car regularly serviced, but most of the parts don’t need very frequent replacing. While you can make good money taking leverage and trading FnO, brokers push it for much higher commissions they get on those products.

Certain ‘star’ traders on social media often claim their strategies as ‘best’ and sometimes the ‘only’ way to make money in the stock markets. You will find that they have their advisory or training link somewhere in their profile. Their primary goal in many cases will be to convince you that to be successful you will have to join their advisory service or take their training.

I will admit that there are some legit trainers out there who can really give you an insight into trading systems. But there are many more who make significantly more money from teaching other people than trading themselves. So every time you see a trader claiming how his is the only system that works in the market, try to figure out his/her motivations. When they show you one card, ask what’s under the card that is face down.

Money value of time

shallow focus photography of hourglass

We all have heard of time value of money. Money left on its own will lose its value to inflation. That is why it is not a good idea to leave a fortune to your grandkids in hard cash. Traders and investors often talk about opportunity cost of their trades and investments. For example, if a trader has an option to take a position in one of the two stocks in front of him. The one he chooses goes up by 5% and the one he didn’t choose goes up by 10%, then the opportunity cost of that trade has been 5% returns.

To give a much simpler example, let us say there are two good football matches going on at the same time; Manchester derby and El classico. Then the opportunity cost of watching the derby would be El classico and vice-versa.

Let us say you work for 10 hours a day and get paid about 1,000 rs per day. It is not uncommon for someone to spend about 2 hours per day on smartphone. So that means it costs you roughly 200 rs per day to use the smartphone. thats about 1000 rs for a 5 days work week. About 4,000 rs for a 20 days work month. about 50,000 rs for a year. That is just the time value of the smartphone, The cost of device, internet etc are additional.

In a very interesting documentary, Anton Kreil talks about ditching the smartphone. Though I realized that it is not practical for me to do so, it made me think of all the time I spend on mine. I realized that a lot of notifications I get are simply not that important. While writing this article, I have received following notifications:
A news story telling me how excited investors are for IPO of Jack Ma’s ANT. This is not a ‘news’ per say. A notification telling me price of USDINR. I know what the price is, because the market is open and the chart is in front of me. A notification telling me day’s weather. I live in Mumbai. Its either hot or very hot. Nobody needs a notification for that. There are about 10 more. But writing about them defeats the purpose of writing about time value of money.

My earlier example of 50,000 rs was just to drive home the point. It doesn’t directly cost you money equivalent to your hourly salary to use the smartphone. The cost is more nuanced than that. You could spend that time doing things that could potentially increase your income like learning a new skill, building a business, creating another source of income etc. It could also be spent on exercising, pursuing a hobby, learning to cook healthy meals, or simply chatting with friends and family. In short it could be spent on your physical and mental health. It will keep you fit and save some long term medical costs. And a rupee saved is a rupee earned.

Pretty much all the platforms on the internet today are specifically engineered to keep maximum number of people on the platform for maximum amount of time. Because many earn their revenues from advertising, advertisers like statements such ‘An average user spends 35 minutes a day on our platform.’ It is similar to a billboard company next to a busy highway stating that roughly 10 lac people travel along this road everyday. These platforms are addictive by design. Since we know that we need to make sure they don’t enslave us.

I have no beef with the concept of smartphone. It is a versatile tool which has the potential to do a lot more good than harm. But it is just a tool. With very high opportunity costs. We don’t get enslaved to the hammer in our toolbox. Then why let smartphone do it?

The law of instruments…

handheld tools hang on workbench

If all you have is a hammer, everything looks like a nail

Abraham Maslow (Rephrased)

You often see traders with profile descriptions like, ‘Options trader’, ‘Futures trader’, ‘Crude trader’. It sounds cool doesn’t it. Makes you want to pull out your credit card and pay tens of thousands, sometimes hundreds of thousands of rupees to go learn how to do some complicated hedging strategy. But do you really need to?

But what we often forget is all these are tools to achieve your end goal. In this case to express your views about the market. Nobody says they are a mutual funds investor proudly. Why? Because it doesn’t sound cool. It doesn’t involve showing your expiry day profits. But for a mutual fund investor, it expresses her view. It serves her purpose of creating wealth for her financial goals.

Let’s take an example.

You can have very simple view of a stock. ‘From current market price, it will go up’. Now how do you pick a tool? If you have a small account (read: less than a few lacs) it is best to stick to cash market. But lets say you have enough money in your account to play around. If you still want to keep the risk low, you can simply buy the stock. If you want to use some leverage to make more money on the same trade and in return can afford to lose a little more money if the trade goes wrong, then you can buy a futures contract. Options are a little more complicated. You can buy a call or sell a put. You can create vertical, horizontal, diagonal or ratio spreads to create suitable risk reward profile. These are all tools.

We don’t decide what furniture we want in our living room by looking at our toolkit first. Which in this case would contain only hammer and severely limit your options (pun intended).

In my case I prefer to express my views in terms of support-resistance or supply-demand levels. One of my views is that we wont see 9000 on the downside or 12500 on the upside for a couple of months in NIFTY. Then the simplest tool would be a short strangle or an iron condor. Another example is ‘NESTLE would be a good pick for a long term portfolio at current price’. Since its a long term bet, venturing into derivatives would be too risky so simply buying a stock would be better. I won’t have to check the movement everyday and no matter what happens I wont lose more than I have put into the stock. Which, by-the-way, can happen in derivatives.

So design your sofa first. Then go pick your hammers and chisels.