Kaufman tests his concepts using a “live” Excel spreadsheet with prices that will update continuously. “You run your moving averages in columns or rows along with other simple techniques to show, for example, if a market is in a trend,” he says.
Once you optimize the concept and it backtests well, continue to test it using out-of-sample prices as they print. Some charting programs have a simulated brokers function to forward test concepts.
Next, create a phantom trading account. As you enter an order, it is executed when a real price prints, regardless of volume. Trades are posted to your phantom account that keeps a running profit and loss. Be sure to enter brokerage costs. Subtract one tick for opening a position and another for closing it.
Kaufman says that if you develop a trading concept that doesn’t forward test well, dump it and start over with another concept. “You can’t go back and redo it,” he warns. “That’s a feedback loop. It never works.”
Rockefeller and Kaufman argue that new traders should have the lowest leverage possible because they are learning. Even professionals underestimate the effect a single price shock can have on their capital.
“Price shocks can press you to the wall on days like the May 6 [flash crash],” Kaufman says. The June E-mini S&P closed down 41.50 points ($2,075) from the open. That day’s range was 112.75 points ($5,637.50). “Before you begin choosing software, fix on what percentage of your capital you are going to risk on each trade,” Kaufman says.
A few vendors offer risk management programs and while they should be explored, you should have a solid risk management strategy in place before choosing a software vendor.
A risk that is often overlooked is order entry. Slow electro-telephonic connections, computer failure, and delayed data can all contribute to slippage you hadn’t planned for or even expected (see “Disaster avoidance and recovery,” below).
There are numerous software tools to allow you to execute your trading strategy successfully. Once you clearly define your approach and needs, selecting the proper tools will become much easier.
Desmond MacRae is a New York-based business writer specializing in banking, finance, and investments. E-mail him at firstname.lastname@example.org.