How to trade the Budget

Like many desi institutions, the Budget and its traditions are relics of the British Raj.

It used to be presented in Westminster at noon, GMT (=17.30 IST) on the last working day of every February. After Independence, India's Finance Ministers continue to rise and clear their throats at 5.30 pm until as recently as 1998 when Yashwant Sinha pulled it back to noon IST.

All the ceremony is frankly, a waste of time and money. It would make more sense to upload the documents on government websites at dawn and let Parliament move straight into debate. However, efficiency and cost-effectiveness have never been high priorities for Bharat Sarkar

The release of the Economic Survey (ES), and the Railway Budget on the two preceding Parliamentary sessions sets some sort of direction for sentiment. The ES is often seen as an indicator of Budgetary thrust and the Railway's performance is closely linked to GDP trends.

But Budgetary provisions always differ significantly from ES recommendations. This is not a transparent "what you see is what you get" document. The fine print of annexures and departmental notifications takes weeks of micro-analysis to dissect, debate and digest. After all that analysis, it's still a toss-up if the Budget will be "good" for the economy.

The stock market however, reacts instantly to every sentence spoken by the FM and the reactions can be any which way. So there is a case to be made for staying out of the stockmarket until you can sit down with a cold towel around your head to do the micro-analysis. That's what many sensible value investors do.

But for a trader, staying out around the Budget means leaving large potential profits on the table. The Budget speech is usually sandwiched inside several sessions of high volatility and high volume that are caused by it. Prices move erratically and with greater momentum from a few sessions before, while B-day itself is often violent and sharp trends can develop.

If you control your nerves and handle that extra risk sensibly, it's like a cricketing powerplay: higher risk tied to higher reward. If you can navigate the extra turbulence, you can generate very high short-term returns.

Trading during the Budget period - for say, the five sessions before and five sessions after, requires a special approach. Broadly, it means implementing discipline to cut off losses, while trying to maximise potential gains. Here are some thoughts and suggestions that could help you trade the Budget.

1) Ideally, don't touch equity directly at all. Focus on the derivatives segment. Trade only the futures and options of the Nifty, the BankNifty and the 10 or 20 most highly traded stock futures.

You expect volatility to increase. But you don't know directional bias. You need high liquidity and breadth of coverage. You may need to reverse trades quickly. Selling equity, particularly short-selling, is cumbersome and you can't hold overnight shorts. Sticking to liquid stock futures and indices ensures you can go short or long with equal ease.

2) Don't go bargain-hunting for small caps or even medium-caps in the Budget period. The Budget is a blunt instrument. If it affects a sector, it probably affects all businesses in that sector. Budget sentiment is powerful and contagious - most stocks will move in the same direction. Certainly, stocks in the same sector will..If you get the sector right and trade the stock futures or equity of market leaders, you will get decent returns. If you get it wrong, a small stock will be tougher to exit or hedge.

3) Go with the trend, whatever its direction. Sell as happily as you buy. You may be a long-only or short-only trader by preference. But when trends develop around the Budget, they tend to be very strong, in the short-term..The trend is your friend - ride it. This is one of many reasons to prefer derivatives - they allow easy shorts.

4) Don't be a contrarian - the risks are too high. Do you think the market is responding irrationally to the speech? Well, the market can stay irrational longer than you can stay solvent. Don't anticipate a change and trade against a trend.

5) Consider "buying on rumour and selling on news". There are always rumours, credible ones, before Budget. Those rumours move prices. If the rumours are wrong, there are big corrections on B-Day. If you go long on the rumour and short as news breaks, you may gain both ways.

6) Keep stop-losses. Before you enter any trade, decide how much you are prepared to lose. Structure your position sizes around the maximum losses you are prepared to accept. High volatility and derivatives leverage is a potent combination, which can clean you out as quickly as it can make you rich. Stop losses can be noted mentally or entered as firm orders. But if a stop loss is triggered, exit. Cut your losses. (See the Box on stop-loss calculation for some ideas on handling stops.)

7) If you're comfortable with index options, use them. Nifty index options can help construct positions that are automatically hedged to limit maximum losses and capable of generating profits, whichever way the market moves.

8) Keep an eye on commodity exchanges and the forex markets. Both offer superbly-leveraged, high volume derivative markets. Budget-related trends develop there as easily as in the stockmarket. Sometimes commodity and forex trends are more obvious, persistent and rewarding.

9) Don't set "stop-profit" targets, revise stop losses. If you set a profit target and exit, you are limiting potential gains. Don't do that, move your stop loss instead. For example, suppose you take a trade, with a stop loss @1.5% away from your price and the trade gains 5%. Move the stop loss to within 1.5 % of the new price and carry on.

10) Adopt, modify or reject any of the above suggestions if you disagree with them. But consider them carefully before you decide on your Budget strategy. No trading strategy works all the time. You might find more effective ways to turn a profit without risking massive losses.

All the best and have fun second-guessing Pranab-babu!