Vivek Gadodia: From system analyst to market wizard

His background in systems and his experience in trading led him to the second position globally in designing market neutral algorithm of US equities in a competition conducted by one of the world's largest crowd-sourced hedge fund.

Vivek is a co-promoter of Dravyaniti (www.dravyaniti.com), a fin-tech company that is into research and development of algorithms in the financial markets. They develop rule-based trading strategies that are deployed by the broker's proprietary funds. Their company is now in talks with Alternative Investment Funds to customise their models to the needs of these funds.

Vivek is a movie buff, especially market movies, and going on treks to lakes in the Himalayas. The little free time he gets he loves spending it with his family.

In an interview with Moneycontrol Vivek speaks about his journey as a successful trader which he says has also been a journey in self-discovery.

Q: How did a system analyst become a trader?

A: It was a slow but natural transition. My background is in commerce and I have an MBA in Systems from Sydenham College, Mumbai. Post my education I got a job in a software company called CMC, which was acquired by TCS. My job there was as an analyst cum programmer for the treasury division. It was here that I was exposed to forex trading.

While writing the software in the treasury division the market caught my fancy. Perhaps it has to do with my exposure to the market during my school days. My grandfather used to dabble in stocks and he always asked me to mark the share prices of his portfolio in The Economic Times. I had seen prices move up and down in my early years but did not make much of it. Now in CMC, it all came back and I could relate to what was happening. In order to know more about what was happening, I started reading as much as I could on markets.

Later I joined HSBC Bank, but here I was posted in the technology side of their human resources department. While I had no direct exposure to the market, I was bitten by the bug. This was the 2004-07 period, one of the biggest bull runs in the Indian market.

My interaction with friends and colleagues was all about markets. I was more interested in news and developments in the market during those days.

Though I used to trade in a number of stocks the primary ones were from the IT sector. I remembered reading Peter Lynch who said that we should stay in companies and industries that we understand.

I came across a Deloitte report on the top 200 IT companies, I picked up the top three companies from it and started trading. I remember Geodesic and Cranes Software, do not quite remember the third one. I remember telling all my friends how great these companies were and why they should own it. Markets were so strong back then that my trades on very basic knowledge would do well.

Then one day in July 2007 I saw visible greed in the market and decided to sell all my stocks. One event which led me to do this was something that happened in our company – HSBC.

Being associated with the HR department of a multinational bank, we could see the effects of the bull market in our hiring. Back then we were hiring entry-level MBAs, who were not from top-level business schools and paying them more than a branch manager, an IIM graduate with more than five years of experience.

Warren Buffett's quote of one should be fearful when others are greedy flashed in front of my eyes. I felt that things heating up too much and decided to sell my portfolio. By July 2007, I was sitting on cash. In fact, I went a step further, I bought puts. But by December 2007 I had blown up my account as the sharpest rally of the 2004-07 bull run took place in the last six months.

In January 2008, while going to my office, I got a call from my father saying that the market had hit the lower circuit. I felt vindicated with the fall but at the end of the day, I did not make money. Being right in your view and making money on your view are two different things. I decided to find a way to integrate the two.

Q: How did you come back in the market?

A: I made up my mind to get in the financial technology space. I applied in many companies and got a call from Lehman Brothers in early 2008. I was rejected because I could not explain what MBS (mortgage-backed securities) was (Lehman Brothers filed for bankruptcy on account of MBS exposure among other leveraged positions).

I managed to get a job in Philips Capital. I was working with a team that was responsible for setting a high-frequency trading (HFT) – algorithmic trading desk for a bunch of traders who were returning back to India from the US.

By now I was deep into trading books. I had discovered that I was not a buy and hold type of guy but preferred trading. Within trading, I preferred trend-following than other forms. The turning point for me came when I read Ed Seykota's interview in the bestselling book Market Wizard authored by Jack Schwager.

In 2008,  I also took a part-time Applied Finance course with IIM Calcutta, which helped me appreciate derivatives better.

By late 2008, I was again in the markets. This was the time of extreme pessimism. I remember discussing with a friend a day when there was only one share traded in Shoppers Stop. We were discussing that something had to be done, markets cannot go on like this for long.

By March 2009, Nifty crossed the 3,000 marks, technically the first sign of bullishness for me. Some of the good technical analysts that I was in touch with also saw the change in trend. But the offices in which they were working prevented them from giving buy calls to their clients. I had no such restrictions as I was trading in my account.

But I was also cautiously bullish and for every three long calls, I bought a hedge. As the markets entered into elections, I was holding a buy position. Post the election result, market hit the upper circuit. This one move helped me recoup all my losses made in the second half of 2007.

By 2010, I decided to quit my day job and get into Algorithmic trading full time. Those were early days and few people had even heard of this term. I started off with money from family and friends.

This was the most testing phase of my trading career. I made all the possible mistakes ever written about. Slowly, but surely, I started making progress by learning from my mistakes. It took me two years to find my mojo. By the time I got my first client as a trader it was December 2012, nearly two years after I quit my job, but by now I was baptised by fire and was confident of my abilities.

Q: Psychologically, did you go through any changes during this period?

A: The biggest hurdle to me was psychological. I was only a trend-following trader back then, and as you know the general win-loss ratio of a trend follower is low. In my case, it was around 35-40 percent.

I have been a good student throughout my school and college life, who topped the class and studied to get the perfect score. This 35-40 percent win rate in the market did not match with my expectations of being right all the time.

I was constantly in search of the proverbial Holy Grail. The eureka moment for me was the Ed Seykota interview in Market Wizard. His 'Whipsaw Song' exemplifies the predicament of a trend follower. He says 'One good trade makes for all the small losses' which clicked with me.

Q: How did you trade in your earlier days and how did you evolve?

A: I was only a trend follower during my initial days. I used the Donchain Channel on a three-minute timeframe and traded in four to five stocks. During my initial days, I used to trade on intra-day basis.

This was mainly because I had seen the Algo traders at Philip Capital trade profitably on an intra-day basis, and this was ingrained in my mind. I was under the assumption that Algo trades work better on an intraday basis. My trading decisions were also to some extent influenced by newsflow and discussions with other traders on what they were doing.

However, when I was logging my trades and referring to them again I noticed that my trades would have given better results had I held on to my position over the next few days.

Post this realisation, I shut all noises -- switched off business channels on TV and stopped discussing markets with others and looking at charts. My performance improved considerably. Risk management and positional sizing further helped improve my performance.

The Rs 10 lakh from my first client reached Rs 15 lakh in three months. My confidence improved and I added a couple of more stocks. I scaled up slowly adding more clients over the years.

In these formative years, I diversified and added currency and commodities to my trading basket. The basic strategy remained the same, but we tinkered with the timeframe. In the case of currency and commodities, we moved to a 15-minute timeframe. We scaled up our currency trading so much that we were the largest non-bank trader in some currency pairs.

The high leverage the currency market offered, helped us improve our performance. Our best period was around August 2013 where the rupee moved steadily against the dollar and equity markets were tanking. In essence, both were trending. In one month, we managed a return of 80 percent and our overall portfolio almost doubled in that month.

However, after Raghuram Rajan became the Reserve Bank India Governor in 2013, volatility in the currency market reduced. We started reducing our position in the currency market and focused on equity markets. Commodity markets too were moving sideways and managing these trades after equity markets closed was no longer remunerative. This helped us increase our focus on equities.

Just as in the 2009 elections I was able to catch the up move in 2014 elections. Many people prefer to stay out of the markets during election times, however, our back-testing has shown that ahead of a big move in the market the charts on the hourly or lower timeframe start moving in line with that trend well ahead of the event occurring.

Even in case of the 2008 fall, the lower time frames were all in the sell mode well before the lower circuit in the market. Same was the case during the upper circuit in 2009.

The difference in 2014 was though the market had given a buy signal, because of the size of our fund, I started to hedge my position. Thus even as the market moved higher my return was off the mark because of the hedges.

As we grew in account size and the number of clients increased we grew more cautious, our mindset moved from chasing returns to controlling risk.

Q: How did you go about improving your performance?

A: During my earlier phase, I was running a stop and reverse strategy, which meant I was always trading in the market. This strategy was either giving a buy or a sell signal. While the strategy was working very well in a trending market, I was not comfortable employing this strategy in a sideways market. As liquidity dries up in a sideways market, it resulted in higher execution cost – a double whammy on my returns.

After a lot of reading and attending trading conferences I came up with an idea of adding a second timeframe – a higher one as a filter. I researched and optimised on timeframes and finalised on 30 minutes. My trading timeframe remained three minutes however my first filter was 30 minutes.

If I want to take a long trade, the moving averages on the 30 minutes timeframe should suggest a buy. I will then take the next buy signal on the three-minute timeframe. I undertake the trade when all timeframes are aligned. This filter helped me in improving my returns in a big way.

I use other filters such as ADX (average directional index), an indicator which determines the strength of a trend.  If ADX is above a certain level, only then I am looking to go long or short in a particular stock. After adding ADX, my number of trades reduced, but more importantly the drawdowns were lower without compromising on my returns.

This two-three month period where I was testing every method to improve my returns was one of the most rewarding periods of my trading career. The challenge for me in selecting the filter was not to lose the core of my original strategy but to improve my performance.

The other thing I worked on was the stock selection. This was after a chat I had with an institutional trader, where we were discussing my style of trading. The trader asked me why I was trading the same set of stocks every time. I told him I have back-tested my strategy in these stocks and it worked very well.

He asked 'Which part of the country I was from'. I told him I was from Rajasthan and my forefathers migrated to Mumbai many years back. He asked 'Why did they migrate to Mumbai.' To which I replied 'In search of better opportunities.' He quipped 'That is exactly what I am trying, trade in stocks where there is an opportunity rather than stagnant stocks.'

This idea struck a cord with me and I began to look at stocks offering better opportunities.

I found that the equity curve of a system is mean-reverting, which meant that the trading system will fluctuate between making and losing money. If we take care of the winning phases and let them run, then the equity curve will have a steady upward slope. If we trade in a stock moving sideways, it will impact the equity curve and portfolio returns.

In the case of State Bank of India, the stock was offering a decent return during 2012-15. But over the last two-three years, it was moving in a 150 point range. If I would have traded this stock my portfolio would have been affected by whipsaws and my capital would have been blocked. It is therefore prudent to trade where the opportunity is.

To select the stocks to trade, I periodically scan my pre-selected list and rank them based on their equity curve. I select those stocks with a higher ranking.  This helps in making my system dynamic. I only trade stocks that are trending and offering better returns. I automatically move out of stocks that are trading sideways.

I have manually back-tested this screening methodology from 2012 onwards and found that this process clearly gives me an edge over trading in a fixed set of stocks. Since the last two years, I have been trading successfully using these filters. Life is more peaceful now and sleep better at night.

Q: How do you exit from your position?

A: While I may choose to enter the day's high or at any such level, my exits are always indicator based. I am completely fine undertaking a trade in the same stock even after it has been continuously stopped out five to six times. I trade using seven strategies and do not risk more than 0.5 percent of my capital in each trade. In some of our large clients, the risk tolerance is 0.25 percent.

Some of my strategies are trend following, while others are based on the principle of mean reversal, while others are based on a mixture of technical and fundamentals analysis.

The core trend-following strategy has a win-loss ratio of 36 percent. The others range between 45 and 55 percent. However, for every Rs 1,000 lost we earn Rs 2,200.

Q: What has been the defining moment in your journey as a trader?

A: This was a day in 2016 when the credit policy coincided with the weekly (Thursday) Bank Nifty expiry day. The market fell immediately after the RBI governor changed the policy rate (repo rate). I shorted the market with a large position. The position was larger than what I normally undertake. The market direction turned and it started to trend higher. At that time, I was also short in the currency market which too started to trend higher.

Since I had made up my mind that the market was headed downwards, I held on to that view overriding my own built-in system. This bigger than normal position clouded my decision-making ability. It did not help that I had partied hard the previous night and was not as alert as I usually am.

By the end of the day, I had 15 percent of our capital. Worse, some clients decided to withdraw their capital based on that day's performance. I was shaken and had my confidence.

I was lucky to have the support of my family, especially my brother who helped me emotionally to get back on my feet. My friends registered me for a Vipassana course, which helped me refocus. For me, trading has been a journey towards financial freedom and has helped me become a better person.

I have given up late night parties and am more focused on my work. Every morning I remind myself never to make that big mistake again. I am fine with taking small losses but a 15 percent portfolio loss is a strict no.

There may be days when I will have to take a big loss, but I ensure that it will not be on account of me overriding my system. Now we have included enough checks and balances in the system itself that will prevent me from overriding it.

Q: What are your future plans?

A: On the trading front, we are looking to improve our risk-adjusted returns. At the portfolio level, we have positive returns 75 percent of the time. We are working towards improving that and adding more strategies to have a market-neutral long-short position at any point in time.

On the business front, we are looking at growing our advisory business by adding more institutional clients and managing bigger portfolios.