Last time, we had discovered that the ‘badla’ session on weekends is not a boxing match between the bulls and bears in the old unused ring of BSE’s famed rotunda, where each tries to take revenge. Instead, we figured out that ‘badla’ is a system that allows traders and speculators alike to transfer positions from one settlement to the other by offering a market determined borrowing mechanism.
We also discovered, by looking at the activities of Harshad Bhai and Munshiji, how the system helps speculators like Harshad Bhai to leverage positions while money lenders like Munshiji get fantastic returns. The interesting fallout of this system is that short sellers get to carry forward their positions too and can earn badla for doing that! We had left an unfinished agenda of learning more about how traders use badla positions and badla rates to figure out market trends and also touch upon issues like ‘Badla vs Futures’, regulations and economic functions of badla. We are back to address the unfinished agenda!
A pink paper’s market commentary: ‘Market fell as badla rates hit 35%...
So what, you ask? Why should it fall? We decided to check with a keen market observer, Mr. Shah. He has been around ever since trading began on Dalal Street!
Mr. Shah: As you would all know, the market is the sangam of a varied set of traders and investors with different views and investment horizons. The market is also an interplay between fundamentals (or the valuations of businesses against visible earnings stream) and sentiment (that factors in future expectations). Let us try to understand how badla captures useful information that can help predict market trends through the activities of my own two sons! Ketan, my eldest son, is a smart trader who has seen me learn the hard way and has gained better insights. Amit, my younger son, is more impressionable and has taken to trading recently, relying on others for tips.
Ketan Bhai smells a bull market...
During the third week of April 1999, Ketan Bhai suddenly became very bullish. The big brokerage houses were talking of 5000 Sensex level by March 2000. The FIIs were pouring in money. The government had fallen but everybody expected BJP to come back. There were reports of the economy recovering. Ketan Bhai’s eyes turned big with the desire to make lots of money and retire! However, he had just a few crores at his disposal that constrained his ability to take big bets. Ketan was very convinced about his call and desired to leverage his wealth to the hilt. The ‘Badla System’ gave him an opportunity to do it too. "Why not," he said!
Badla to the rescue
Ketan Bhai was a smart trader who did his homework regularly. After all, there are no gains without pains. He pulled out the latest newspaper and scanned the pages to look at the badla positions. He heaved a sigh of relief, comfortable with the fact that the badla positions had dropped to Rs1017cr while the badla rates hovered around 16%. Ketan Bhai did some back-of-the-envelope calculations. A Sensex of 5000 by March worked out to a 40% return (Sensex then was around 3500). With average badla rates always working out to below 30% for a year, Ketan Bhai stood to pocket the 10% spread on one fifth his exposure (remember, traders need to put in margin money compulsorily plus other ad hoc margin requirements) - a 50% return for the year!! Ketan Bhai’s eyes popped out. He rushed straightaway to his broker and bought Grasim, Infosys and M&M.
Amit, on the other hand, believed that this euphoria was short-lived. He felt that FII money was all hot money that would leave in no time. He felt that the sentiment was bad, otherwise everybody would have taken big positions on badla. So, he stayed away.
Market & badla move in tandem
Two weeks went by and there was no let-up in FII buying. The market soared past 3800 in just over a week’s time. The smarter traders jumped in headlong, lest they lose out on the rally. Our friend, Amit, on the other hand was utterly confused. Though he thought that it was set to reverse, everyone around him was shouting ‘Teji’ ‘Teji’ and jumping in. Ketan Bhai, on the other hand, was very happy with his performance and closely monitoring the badla rates and positions. The market got past 4000 in this frenzy. Amit could wait no longer. He called up his broker and asked him to buy Rs50lac worth of stocks in carry forward position (positions that are carried forward from one settlement to another through the badla system).
Chart 1: Market & Badla move in tandem
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Market gains too much of fat
The second week of July, the index closed at 4639 levels. The badla positions (the fat of the market) had increased to Rs1346cr. The broker called up Ketan Bhai and informed him that the badla rates had shot up to 22%. Ketan Bhai raised his eyebrows on hearing the rate and reworked his calculation. The market had risen too fast for comfort. From these levels, the market had almost reached his 5000 target by year-end, an upside of just 9% whereas if he opted to be the financier, he could pocket 22%! Ketan Bhai also figured out that with the market having risen so much and badla positions increasing now, it would need Herculean amount of buying or some very positive triggers like a landslide political victory, record monsoons and fantastic results from corporates! Too much of hope! Ketan Bhai resolved to sell all his stocks on Monday. Amit, on the other hand, was quite enthused by the index closing and big badla positions. He decided to buy more on Monday and carry the positions forward! Next week, the market opened with a bang as everybody rushed in. Ketan Bhai sold happily and left instructions with his broker to put his money in badla, i.e., act as a financier. Amit stretched to his limits and bought more stocks. Ketan Bhai flew to Goa that weekend to celebrate.
The plump market collapses
The subsequent week, the market opened higher. But with everybody having built positions with a short-term horizon and FII buying reducing, the market lacked momentum. To add to the woes, the local institutions started selling. That week, the market closed lower. Amit started twiddling his fingers before the badla session. The badla rates shot up to 24% while positions had also increased to Rs1538cr. Ketan Bhai had a big smile on his face after he heard about the badla rates from his broker. Amit started losing big time as the market began falling sharply subsequently, with FIIs also pressing for sales. He had paid a higher badla rate that added to his cost while the market had come off 10% in absolute terms. Most traders like Amit rushed to square off transactions in a hurry, sending the market to 4488 levels. Meanwhile, Ketan was comfortable with a 5500 Sensex level (The same brokerage house was after all talking of 6000 now!). Suddenly, the upside looked better for Ketan Bhai (25% assuming a Sensex level of 5500 by year-end!). Ketan Bhai called up his broker to ask him to buy stocks and keep it as a carry forward position. The cycle continues...
Mr. Shah: Badla offers an outlet for traders like Ketan Bhai and Amit to trade. It provides scarce capital to traders willing to take the equity risks. Thereby, it ensures better volumes and higher liquidity in the market. However, badla can be a double-edged sword, as it can create a bubble in the market that gets crushed. In other words, over-leveraging will lead the market to run ahead of expectations, scaring long-term capital away from the market by skewing the risk-reward ratio. In the process, markets can be fairly volatile. The unfortunate situation with our market is that capital allocation and risk allocation happen together, as there is no futures market! Ideally, cash markets should only serve the purpose of capital allocation, while the futures market facilitates risk allocation through hedging and speculation! Our market is like the Ganga - the holy water is used for all kinds of unhygienic activities!!
Mr. Shah’s making sense but he is being very abstruse (abstract!). Let us handle this topic next time.Soon, the chapter on badla will stand closed. Till then, happy badla!!
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