Trading and Investing Performance on 31/3/2017

Portfolio performance in the last 4 months
Trading and Investing Performance
Chart showing my investment and trading performance against the indices and good mutual funds


I don’t want to comment too much on this chart, since it is only a 4 month performance.

It is obvious though, that good mutual funds like HDFC Top 200 have outperformed both my equity portfolio as well as my trading.

As is obvious with a system based on leverage, my trading performance fluctuates wildly, while the others are more or less with similar trajectories.

There is usually mean reversion in markets, and so over a period, my investment portfolio’s performance should improve.

The methodology of calculating the NAV’s have been mentioned in an earlier post on measuring investment performance.

Investment performance has been slightly understated, because I have not taken dividends into account.


Portfolio Composition as on 31/3/2017

Porfolio Composition
This is the portfolio composition at the end of the financial year 2016-17

Please refer to my earlier post on my portfolio composition goals.

Again, I would like to emphasize that over a period of time, I expect to see the allocation to real estate decreasing, and the exposure to trading equity increase. I would also like to steadily add to the stock of bullion and low yield instantaneously redeemable debt in the portfolio to increase, to add to the stability of my trading business.

My goal is simple: To derive a 15-20% return on investment over the long run. I shall be quite satisfied if over several years, I am able to achieve this goal. Portfolio composition is very critical to achieving this goal. Too much exposure to “safe” low yield debt, and I would not be able to achieve the goal. On the other hand, too little exposure to instantaneously redeemable low yield debt would mean that I would not have the opportunity to invest in the market when it is down and out.

How much trading capital does one need?

Trading Capital

How much trading capital does one need?


When one invests in stocks in the cash market (i.e., when taking delivery of the stocks, and holding them for a long time), the notion of how much capital is involved is straightforward. The total amount invested at any point is your capital, and returns must be calculated accordingly.

Trading Capital

When it comes to trading, this is not so clear. This is because of:

  1. Trading involves leverage. Typically, the amount of leverage available is anywhere from 5X to 10X. So, if the money invested for margin is Rs. 1 Crore, the positions created will be anywhere from Rs. 5 Crore to Rs. 10 Crore.
  2. Because of the leverage involved, the amount of drawdown is also magnified. And unlike in investing, the drawdowns (in other words, the mark to market losses) must be made up in cash daily. So, in addition to the margin in a) above, another sum must be kept aside for drawdowns.



How much money should be kept aside for drawdowns?


The answer is not so clear. In practice, I follow the following calculation:


  1. For each strategy I use(Note: I am a purely system trader, I do not use discretion to time my trades, so I can use backtest results. Discretionary traders will not find this post useful), I note the maximum exposure of the strategy (in terms of margin) in the last 10 years. I also note the maximum drawdown on the strategy in the last 10 years. So, if a long mean reversion strategy involves 40 open positions (at a time of a massive fall in the market), and each position involves Rs. 1 lakh as margin, then Rs. 40 lakhs is needed as margin. In addition, if the maximum drawdown in the last 10 years is Rs 40 lakhs, then the total capital to be kept aside is Rs. 80 lakhs. This way I would be able to fund my account in the face of any market condition.
  2. I repeat the above calculation for every strategy I use, and then I total all the strategies up to arrive at the figure of the total capital to be kept aside. So for instance, I would trade two strategies like the one mentioned above, I would have to keep aside 1.6 crores.


This is a somewhat conservative way to go about it. In practice, I would rarely require as much capital, because long and short strategies are rarely likely to both experience a combined drawdown. Also, as long mean reversion strategies kick in, long trend following strategies start getting wound up. So, in real life, I am unlikely to need as much capital. However, it is better to be safe than sorry. I like to have a margin of safety. I therefore keep aside the capital based on the above calculation.

Notice that I am using the phrase “keep aside the capital”, rather than use “invest the capital”. That is because capital can be generated for trading in many ways.

How can trading capital be generated?

  1. Cash  in the form of liquid ETFs (i.e., liquid bees) and broker float. One third of the capital required to be kept aside is invested in this manner. Brokers will give 90% margin against liquid bees. Around 80% of the amount is in liquid bees, and the balance in my broking account. (keeping 100% in liquid instruments would involve transaction fees which may exceed any return expected). This cash of course represents investment in the trading business.
  2. Shares as margin. Typically, brokers will give margin between 60% to 80% on widely traded stocks. Again, I keep one third of the capital required to be kept aside in the form of stocks in my demat account.
  3. The last third is probably likely to be used extremely rarely, in the face of a massive market meltdown. I keep this in the form of overdraft accounts against securities (where all I pay is the annual renewal fees) or in the form of inter corporate deposits (ICD’s which I can call at short notice) and in government securities which can be instantly liquidated.

Why this 1/3:1/3:1/3 pattern? In a way, it is completely empirical.

However,  in a general sense, the margin against stocks represents the “core” margin required on  a daily basis. For instance, if the normal maximum position size is Rs. 10 crores, I require Rs. 2 crore as “core” margin. This can be provided cost-free by taking margin against stocks.

The balance in the brokerage account is usually around 25% of the total cash, and represents normal mark-to market losses for a couple of days. So, if the position size is Rs. 10 Crores, then it is reasonable to assume that two back to back falls of 2% are possible. So to keep Rs. 40 lakhs in the brokerage account is reasonable. The balance in the liquid ETFs is to accomodate large drawdowns, or the occassional spike in position size (I use long mean reversion strategies and long trend following strategies, so in the case of a sharp market downturn, I suffer a sharp drawdown on the trend following strategies, and a sharp increase in the position size of the mean reversion strategies simultaneously).

The balance 1/3 in OD’s, ICD’s and Short term gilts is essentially just margin of safety, in the case of a black swan event, or in the case of a 2008 like market meltdown.

Given the pattern above, how do you calculate the amount of capital invested in trading activity, so as to calculate the return on capital employed?

Calculating the return on trading capital

  1. The cash invested is clearly part of the capital. Liquid ETFs (currently) yield around 6% (pre-tax). Float in a brokerage account does not earn you anything. Hence, the dividend amount received on ETFs should be added to the total trading profit or loss.
  2. When shares are kept aside as margin, then it is not so clear that we should use them as part of the capital involved in trading. The stocks earn capital gains and they also earn dividends. And it is not as if I bought the stocks to invest as margin. I bought the stocks because they are good stocks to invest in. This is just an added utility.
  3. Similarly, when an overdraft account is created using securities as collateral, those securities should not be viewed as capital invested in the trading business. Similarly, ICD’s earn between 11 and 13%, and I might have invested in the ICDs anyway. So, I don’t think those should also be treated as trading capital. However, Government Securities (which earn around 6-7%) should be calculated as part of the capital invested, and the dividends or capitals gains thereon should be added to the total trading profit or loss.

Thus, when you see return on trading capital figures elsewhere in this blog, you should interpret the trading capital in the above manner.