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Now let's enter the last phase of the course.
You learned various strategies some of them based on accounting,
some of them based on stock prices.
For example, Earnings Announcement Drift,
you learned about accruals,
you learned about momentum,
you learned about momentum crashes,
in the process you also picked up knowledge about some financial instruments options,
futures, long, short all that.
And we also talked about backtesting,
we also talked about compliance and other related concepts.
Now, what do we do from here on?
Now that you know about these strategies, what do you do from here on?
Are you ready to start trading tomorrow morning?
The answer is maybe no or a guarded yes. I'l tell you why?
Because as I warned you before,
in one of the modules while talking about a particular strategy,
that actual trading and backtesting are very different.
In actual trading you have a very big thing to take care of,
that's your own emotions which is not there in backtesting.
When you backtest you get
some fabulous return or you lose a lot of money, nothing much happens.
Of course, you may feel happy,
but when it happens in reality it's a different ballgame altogether.
It's important that you get some practice
in a simulated environment before you actually jump into trading.
So what I suggest is that you do your backtesting,
arrive at long shorts,
but start with mock trading.
Don't put in real money as it.
Start with mock trading.
There will be a lot of websites which will have this kind of dummy portfolios.
When I say mock trading, what I mean is the prices are real.
Prices are real, stocks are real but you're not putting in actual money.
It's like imaginary trades so these websites allow you to have your own portfolios.
You can track performance.
You can see what has happened to each stock on a daily basis, weekly basis,
monthly basis as their strategy request and do this for,
say, a couple of years.
This is absolutely important.
That will tell you how disciplined you are.
And try to be as realistic as possible.
Don't- lot of people cheat even in backtesting.
Don't do that because ultimately the market will not give you such opportunities.
Keep the numbers as correct as possible and see what is happening to these strategies.
Do this for a couple of years and if you find that,
what you find with real prices,
what you find with the actual trading is close to your backtesting results,
then you have reason to be more confident.
As I told you, there are a number of reasons why
backtesting numbers and actual trading numbers may be different.
Of course, one is cost,
you have taxes, you have transaction costs, that's fine.
There is also- you know,
the prices using backtesting could be still.
And finally, there's something called impact cost.
That's something that we have not spoken about before.
It's important that you know,
your trading itself can influence prices.
Imagine you are trading in a illiquid stock,
which is not traded for three days,
and you were short.
You need to have somebody on the other side, right?
Somebody who's willing to buy and the buyer,
if he comes to know that there is somebody desperate to sell,
may reduce the price at which he is willing to buy.
The profit that you hoped to make by going short at a particular price,
you may not be able to sell at that price and make profits in reality,
whereas you can do this with the backtest because you take
the last available price and then see what happens to the price- three days.
And you don't take into the account the fact that you trade and bring down the price.
You could bring down a short and similarly when you buy,
you could trade and bring up the price.
So if that happens,
that itself may eat away a decent portion of the returns that come in backtesting.
This is very important to understand.
Please bear this in mind. You should not think that
backtesting gave you like 50% return but in reality you are making only 20%.
There is a possibility that you are dealing with illiquid stocks.
If you are dealing in liquid stocks,
which are in large stocks,
and if your size is small,
then the impact cost is unlikely to be high.
Let's say you're dealing with Microsoft stock and
you're talking about buying or selling few hundred shares,
that won't make much of a difference.
Your actual results would be close to what you get in a backtesting exercise.
Second thing is, you need to stick to the rule.
As I've told you before,
any change that you do should be to the rule itself,
not in the implementation.
Once you decide a particular rule,
this is the strategy, these are longs,
these are shorts, you will hold for whatever number of days,
you should hold for that long.
Let's say the stock goes up by,
your portfolio suddenly up by 20%,
you'll decide to liquidate because
you have- this is called disposition effect by the way.
It's a well known effect where people sell
their winners too early and hold on to the losers forever.
Then you may not realize the kind of return that you get in an exercise of backtesting.
And finally, once you've done all this,
I recommend that you start with a very small amount of your own or friends and family.
Don't straightaway start with money from outside because,
remember I warned you a little bit in a previous module that,
what happens with outside investors is that,
if you have couple of months of losses they may pull the plug at the wrong time.
Just before your portfolio is about to recover,
these people may withdraw their money and you may be in trouble.
So that is why- don't ask for funds from outside investors as it.
Build your own portfolio,
take money from friends and family to the extent possible,
run your fund for a few years,
build a track record,
and then go for a fund with public money,
and obviously you have to fulfill all your commitments,
legal and all other compliance requirements.
I wish you all the best.
We will soon come out with another module
hopefully on text mining and then happy trading.
Wish you all the success in your trading. Thank you.
Ramabhadran ThirumalaiAssistant Professor
Prasanna TantriSenior Associate Director
