Trading is normally compared to an individual competitive sport. Traders are fiercely competitive as they play for the spoils competing against the best in the world in the marketplace. They defend their capital against losses and would extract the most when the odds are in their favour.

In this everyone-to-himself battleground walks in a 16-year-old, a school dropout that too. He gets trampled repeatedly where he blows his trading account many times. However, he perseveres to get a toehold in the market.

Working in a BPO (Business Process Outsourcing) at night and trading during the day, Nikhil Kamath managed to identify the method in the madness. To have an elder brother, who was also a trader, helped. But as Nikhil says, trading is a solo sport no one can play it on your behalf. With nearly 15 years of trading and an enviable track record, Nikhil now has an institution-sized trading book.

His lack of education did not stop his learning process. Nikhil is a voracious reader, reading up on a vast range of subjects, but prefers books on mass psychology.

Nikhil, along with his brother, has co-founded one of the most successful discount brokerage outfit — Zerodha in 2010. When not trading or managing his broking business, Nikhil is seen playing football with his colleagues from Zerodha.

Nikhil has been rewarded as a young achiever by various organisations.

In an interview with Moneycontrol’s Shishir Asthana, Nikhil Kamath speaks about his journey in the market and what it takes to succeed.

Q. Nikhil you started trading when you were 16. What inspired you to take up trading that early?

I quit school around the ninth standard to play chess full time. I used to play for India that time. Around the same time, I started trading. I got interested as my brother was into trading. But after two years I quit chess. I did not go back to school. During this time I managed to get a part-time job in a BPO and continued trading full-time.

Q. So you learned to trade with your brother and what were your initial lessons?

Yes. My initial learning was under my brother. Initially, it was more of going by the day. Trading more by your guts and learning from your mistakes each time you lose money and trying something else the next time. You see trading is a solo sport, it is very hard to trade with somebody. So we used to trade separately on different strategies. I learned from my own mistakes and developed my strategies learning from my mistakes.

Q. Did your learnings of chess help you in trading?

Not directly but maybe on a sub-conscious level. However, the analysis needed in chess is more or less similar to that in the market. You plan for all events that may happen in both the cases.

Q. What about the initial capital for trading, how did you raise the capital?

Initial capital was from the savings that I had from my job in the BPO. I raised money working in the nights. It was a very small capital I started out with. I blew up my small capital two or three times in the first two years.

Q. At what step did you realize that you can be a trader?

I learned mainly from my mistakes. You try not to do the same mistake again. Your trading psychology evolves with time. What I was doing at 17-18 you tend to do something else at 19-20. It keeps revolving and keeps changing. So what we are doing now in trading is completely different from what we did two years back. It will keep on changing, it evolves. I now have 15 years of trading behind me with 13 of them on a full-time basis. Our strategy changes every few years.

Q. Do you completely discard your older strategy and why do you need to change the strategy?

After a couple of years we discard the older strategy as generally, they stop working or giving the desired results. Its partly because other people catch up with it and the opportunity is lost. At the same time markets are evolving which requires changes.

Q. How have you fared in the 13 years of your full-time trading. Can you give us a ballpark or a compounded annual growth rate (CAGR) over these years?

Since the time I have traded on a full-time basis, we have grown at around 50 percent CAGR. But then the markets have also been good in the last 10 years.

Q. Did you go through all the conventional strategies – moving averages crossover, indicators and all that?

Yes. There was a phase fundamental analysis works, there is a phase where technical analysis works. Then we have phases where algorithmic trading works and automating trade works. Actually, after you try everything you realize nothing of it works in isolation.

In the technical analysis, you are betting that the past will repeat itself. You are looking for patterns which will repeat itself in future. After a time you realize it is a hindsight bias. Overall, I believe the fundamental analysis is a better way to play it. So, currently I have discarded technical analysis from my trading.

With time I have realized that market action is random. What happened in last 10 years will not happen in the next 10 years.

Q. So currently your trading strategy is based on fundamentals?

It is fundamental but it is more based on sentiments and market momentum and stuff like that but not really looking at charts and looking for patterns.

Q. How do you measure sentiment?

You can generally read sentiment from looking at buying trend from saying FIIs, mutual funds or looking at put-call ratios. There are market indicators which generally tell you what everybody else is doing and also the price action.

Q. What markets do you trade and how?

More often than not I trade the index and I trade the options. In options, we generally trade on the short side (checkbox on Option Selling). So we are not betting that the market will go up or down, we are more often than not betting that no activity will happen in the market. We basically short volatility. We do some delta hedging strategies also (see box on Delta Hedging).

Primarily what we do in options is we wait for the market to get volatile and we short out of the money options and we try and get the time value. We look at the call and puts IVs (implied volatility is the expected volatility in the stock) and when we believe that they are overpriced and premiums are higher based on expected volatility we try and short them.

More often than not this is how we trade. 90 percent of our trades is betting on nothing is going to happen.

Q. By shorting options you are able to achieve a return of 50 percent CAGR?

The thing with shorting options is you are able to leverage the amount of money you get by writing the option.

Q. What about the fundamental portion of your strategy, what are the things you look at in a company?

In fundamentals we generally look at valuations. For example, now the markets are trading at 26-27 PE (price to earnings ratio) which we feel is expensive. So we would not buy now, we would wait for the market to come down to around 20 PE where we again initiate fresh long. Our buying is not stock specific, it is broad based.

Since we are mainly trading in index we do not do stock-specific research we look at the overall sentiment and the overall market scenario and we try and buy when markets are fairly valued and sell when they are expensive.

Q. How do you manage risk?

Generally, if you allocate your trades evenly and do not allocate more than a few percent in each trade you last longer. We generally distribute our money across many different trades and do not let one trade destroy us. We do not have more than 3-4 percent in each trade. Having said that if a trade is moving our way we try to add on to it.

Q. Do you trade in other asset classes like commodities?

We play other asset classes, we play a lot of bonds. A large portion of our portfolio is generally in tax-free bonds. Some of these bonds like NHAI or IRFC generally give a tax-free return of 7 percent. We do trade in commodities by trading the calendar spreads (See box on Calendar Spreads). We trade during the expiry of the contract to take advantage of the price disparity. We try a lot of arbitrage strategy (see box on Arbitrage) in the commodity markets. The general idea is to trade defensively.

Q. Going forward how do you want to expand your trading?

Given where we are the scale has increased over the years and our proprietary fund is significantly large, we are planning to set up an AIF (Alternative Investment Fund) sometime in the near future wherein we might start managing money for others. Right now, as we speak, we do not give advice to clients or manage money for anybody.

We have been nudging and playing the international market but nothing large. We do invest in international stocks but it is nothing big time.

Q. Given the size of your fund, is size creating a problem for you to trade in India?

Nikhil Kamath: It does because the markets are not liquid. In fact, if you enter a large order you cannot buy beyond a point without hampering your impact cost.

Q. Have you ventured into algorithms, high-frequency trading (HFT) in your trading?

We do run algorithms on our strategies where we take advantage of price mismatches in various asset classes. We also do run HFTs, though not really high-frequency ones. Whatever strategy we are running we try and automate it which takes away the human element from the slippages.

Q. At what point did you think of starting Zerodha?

We started Zerodha in 2010. But before Zerodha, I and my brother used to have a partnership called Kamath Associates where we used to manage money for wealthy individuals. We were also a franchisee for Reliance Money, Way to Wealth. We also managed the portfolio for India Bulls, this was like 12 years ago.

Q. For someone who has grown in size from being a retail trader what would you like to advise a person who is learning the ropes

Most importantly he should not walk into trading with unrealistic expectation. As long as you can walk into the market with hoping to make 15-20 percent a year you would not take too much risk and too much leverage. As long as the trader goes by reasonable expectation and does not chase the fads of the year either in terms of stocks or indicators and sticking to your strategy and building your own strategy he should be okay. Basically he should come in with a game plan and not to get influenced by the noise in the market.