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Your PC can help you make millions

By Larissa Fernand
Last updated on: November 11, 2005 17:40 IST
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For someone who claims to be an avid stock market trader, Nalin Pasricha is fairly 'chilled out'.

By 11am, most traders would already be into the thick of trading, aggressively trying to cut losses or hit home runs.

But you won't catch Nalin with the phone to his ear or eyes glued to his computer screen. On the contrary. He has a fairly flexible agenda interspersed with periodic checking of the market.

Does he have a lot of flunkies to do the job? Nope. It's a one-man show.

Yet, by the end of the day, he would have completed at least a few crore in volume for himself and his clients.

And his returns? An average of over 100 per cent per annum.

The number of stocks he would have traded in? A maximum of (just) 30. These chosen few are selected from various sectors and are available for derivatives trading on the National Stock Exchange.

How does he manage that?

Upfront, Nalin comes clean: "I am not an investor but a trader." A derivatives trader, to be more precise.

An investor will think long-term, analyse the fundamentals of the company before taking a buy-and-hold position and then hope to benefit by dividends and compounded business growth leading to a substantial capital gain.

A trader is not that far sighted. His rationale: even if a stock continues a gradual upward trend, there is money to be made in the journey. Every climb and descent has potential for returns. You make money when the market is going up or down. If you keep buying and selling at various positions, you would end up continually making (and even losing) money.

It is at this juncture that Nalin parts company with other traders.

Most are discretionary traders but Nalin is a systematic trader (a rare breed in India).

Discretionary trading is subjective. Based on news, market information, research and technical analysis, a decision is made on entry, exit and position size.

A systematic trader relies on the decisions generated by his software programme. Based on mathematical relationships and various inputs, the system operates on a set of rules. 

For instance, a very simple rule put into the system could be: Buy when the PE goes down for three consecutive days and sell when it goes up for five consecutive ones.

The system would automatically buy and sell based on these rules.

Does systematic trading work? If past performance is anything to go buy, the answer is a resounding yes!

A walk into the past

A chartered accountant by profession, Nalin found himself working as an investment banker (a job coveted by others but detested by him) with Jardine Fleming and J P Morgan.

One night, a friend in the Navy invited him over for a meal and asked him to verify a trading system that timed the market. The first trade his friend gave him was: Buy RIL on Wednesday, sell on Thursday.

Totally flabbergasted and cynical, Nalin did so. It worked.

Then he did it with Dr Reddy and a few others. It worked again!  Well, almost (there were losses too). Intrigued, he decided to pursue this.

Another friend who raked in big bucks just by investing on fundamentals told him he was barking up the wrong tree (he heard this a lot).

Partly out of a passion to make money out of this system and partly out of a desire to silence his skeptics, Nalin got cracking (at the cost of putting his career in investment banking on the line).  

Starting 2002, Nalin spent a year (unemployed and avoiding skeptics) focussed solely on research, study of quantitative analysis, mathematics, statistics and computer programming to come up with a system. He purchased NeuroShell Trader for over Rs 100,000 and Wealth-Lab Developer for around Rs 25,000. Both were software trading development platforms to help launch his product.

Not making much of a headway, he almost gave up. Thanks to a stranger-than-fiction coincidence, he came across a paper authored by Xavier Gabaix, then assistant professor of economics at Massachusetts Institute of Technology, and a few physicists. 

The paper, published in Nature (May 15, 2003), claimed that just as it was possible to determine an earthquake, it was possible to determine the direction of the market.

The essence of the paper was that the artificial world (stock market) follows a similar pattern to that found in the natural world. So though the stock market is characterised by a fair amount of randomness, at the end of the day, a pattern emerges that matches power-law (mathematical relationships between the frequency of large and small events) patterns found empirically in data from systems such as earthquakes. 

Totally fired up, he once again tried his hand at it. This time, he came up with a product which he called Seismo (in honour of the above paper which set him down this path).

He then spent months back testing the system.

His software combines trend following and anticipatory systems. So if the market is on a rise, the system goes long and if it is sliding downward, it goes short. This way, it follows the trend. Simultaneously, it also predicts the direction of the market with advanced mathematical computations. But here too, the predictions are just for a few days, not long term.

The rules his software follows are based on a variety of inputs such as price trend of the stock, volumes traded, interest rates and data from the derivatives market.

Though he has been trading using other systems for the past three years, his product - Seismo - was ready by August 2003.

Every evening, he looks at this software and sees the recommendations on each stock. By 10 am the next morning, he places the trades.

Where's the catch?

Nalin has been trading in such a way for the past three years. Which brings us to the perennial question asked of traders: How has he fared in a prolonged bear market?

In a bull run, everyone and his aunt, would have made money. But the test of a savvy trader is how much of dust he manages to kick up when the bears are doing a jig on Dalal Street.

Nalin has not had the experience of systematic trading in a bear run so all we have to go by is how he has traded with sharp corrections.

May 17, 2004

As news of NDA's (National Democratic Alliance) defeat began doing the rounds and Leftist leaders started shooting their mouths off, the stock market fell precipitously.

The Sensex fell 842 points during the day and recovered around 300 points. At the end of the day, when the stock market closed for trading, the Sensex had fallen 11.41 per cent or 565 points -- the second biggest fall in the history of the Bombay Stock Exchange. The Nifty opened at 1582 and closed at 1388.

That day, when other traders would have lost their shirt (and probably their pants too), Nalin could not wipe the grin off his face. He made a cool 50 per cent profit on his personal portfolio. One of his clients booked profits midway through the day and landed up with a 60 per cent profit.

All he did was short sell and leverage. Or rather, his system did so.

October 2005

The market turned volatile and the much talked about, inevitable correction took place. Nifty touched a high of 2699 and a low of 2390 that month. Overall, the market dipped 8.85 per cent. He made a 25 per cent return on his portfolio.

Does that mean his software generates phenomenal returns consistently? He himself is quick to refute that claim.

Here's how he explains the downside. On an average, around seven months in the year will make money. So, if you invest Rs 10 lakh (Rs 1 million), you should make around Rs 300,000 a month, which will translate into an annual earnings of Rs 21 lakh (Rs 2.1 million). The losses for the balance five months would be around Rs 200,000 per month, which will total to around 10 lakh (2 lakh x 5 months).

The net profit per annum on Rs 10 lakh, would be Rs 11 lakh {(Rs 1.1 million) over 100% return}.

Nalin also clarifies that a single year may not give an over 100 per cent return, but over a few years, it all averages to that.

So who does he trade for?

He refers to himself as a prop trader. Nothing to do with real estate; its an abbreviated version of proprietary trader.

When a financial firm trades in stocks, bonds, derivatives or commodities with its own money (and not those of its clients and customers) and with the sole aim of making a profit for itself, it is referred to as proprietary trading.

Sometimes, they hand over the task to another (like Nalin). He gets a percentage of the profits.

His clients are stock brokers, trading companies, corporates and high networth non-resident Indians. Ask him to name a few and he does not oblige - breach of confidentiality, he says.

Ask him how much he makes and all you get is a grin in response (a very self satisfying one). Taking into account that he gets 25 per cent of the profits of his clients (no other fee is charged) and the fact that he actually trades for himself, you can just let your imagination figure that out.

Not bad at all for someone who spends the better part of his day 'chilling out' and figuring out how to upgrade his system to come up with a version for commodities trading.

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