"Choti diwali" falls on the day before Diwali. There are two legends behind this festival.
One famous story behind the celebrations of Chhoti Diwali or Narak Chaturdashi is about the demon king Narakasur who was ruler of Pragjyotishpur, a province to the South of Nepal. During a war he defeated Lord Indra and snatched away the magnificent earrings of Mother Goddess Aditi who was not only the ruler of Suraloka but also a relative of Lord Krishna's wife, Satyabhama. Narakasur also imprisoned sixteen thousand daughters of Gods and saints in his harem. When Satyabhama came to know about this malevolent act of Narakasur she got furious and she prayed to Lord Krishna to empower her so that she could destroy Narakasur. The legend also tells that Narakasur was under a curse that a woman would kill him. So Lord Krishna empowered Satyabhama to fight with Narakasur and himself became the charioteer of her 'Ratha' in the battlefield. Thus by the grace of Lord Krishna Satyabhama beheaded Narakasur on the day previous to Narak Chaturdashi and released the imprisoned ladies from Narakasur's harem and also recovered the precious earrings of Mother Goddess Aditi. In order to save all those imprisoned ladies from embarrassment Lord Krishna accepted them all as His wives. As a symbol of the victory over Narakasur Lord Krishna smeared His forehead with the demon king's blood. Then Lord Krishna returned home with His new wives early morning of the Narak Chaturdashi day. The womenfolk massaged scented oil to His body and gave him a good bath to wash away the filth from his body.
Another legend is about King Bali, who was king of the nether world. His power and increasing influence posed a threat to the security of all 'Devatas' so they prayed Lord Vishnu to help them out. To help Devatas and to curb King Bali's powers Lord Vishnu went to King Bali in the guise of a short-height 'Brahmin', who is known as incarnation of 'Batu Waman', and begged to give him only that much area of land that he could cover with in three steps because King Bali was well known for his philanthropy. King Bali saw just a short-height 'Brahmin' asking for a little piece of land so he proudly granted him his wish. That very moment that short-height 'Brahmin' disappeared and there was almighty Lord Vishnu in place of him. In his first step Lord Vishnu covered the heaven and in the second step the earth and asked King Bali where to put his third step. Then King Bali offered his head to Lord Vishnu. Lord Vishnu put his third step on his head and pushed him deep into the underground. But at the same time being impressed by his generosity Lord Vishnu gave King Bali the lamp of knowledge and allowed him to return to earth once a year to light millions of lamps.
The mother of Narakasura, Bhoodevi, declared that the death of her son should not be a day of mourning but an occasion for celebrations. Since then people celebrate diwali with joy and fun every year.[Source: I love India]