Experienced traders will tell you there are three important components in trading successfully. In order of importance, they are: The right psyche or mental outlook, a money management method to tell you how much capital to commit and when to exit, and a system to guide your trading decisions.
“I think that’s true,” says Perry J. Kaufman, a trading systems innovator and author of “New Trading Systems and Methods.” His advice about using software to trade? “When you decide you want to trade, investing in software is the last step you take, ” he says. “Philosophically, you have a lot of decisions before you even [start] implementing a strategy using software.” This leads to the ancient Greek advice: know thyself.
Are you a short-term or a long-term trader? Can you sell losers quickly? Can you take losses and keep your trading focus? Can you sit in front of a screen all day watching for the beginning of a trend, looking for certain price patterns to appear, or waiting for convergences or divergences to set up mean-reversion trades? If you can’t live with that, you will have to create systems, as Kaufman has for almost 40 years.
Today, the components of trading platforms are perhaps smaller, faster, and so cheap that with overheads of $250 to $400 per month (excluding brokerage), one-lot futures traders can build platforms for their particular market comparable to what institutional prop desks are using. Virtually all of them run on Windows 7 or Windows XP. However, Microsoft announced it will stop supporting XP at the end of 2013.
If you know how you want to trade, here are the components you need, whether you trade in days or minutes:
- A charting program (Free to $100/month)
- Price data ($220 to $320/month, including exchange fees)
- A broker ($5 or less/round turn)
- A disaster avoidance/recovery plan (Free)
- A daily trade record or trade log (Included with software)
- A risk management plan (Free)
Some programs perform just one of these six components. Others bundle some of them. Our goal is to guide your thinking regarding how to make software selections that best fit you.
It is important to have the right tools to determine what you need to execute your approach now and in the future.
Many vendors can be found in the 2010 Guide to Electronic Trading (GTET) inside this issue. Ideally, you should test as many as possible before settling on one. Many software vendors offer free trials from a week to a month.
Charts are pictures of price action. “Technical analysis is a more than 100-year-old body of accumulated knowledge you can use to guide your trading decisions,” says Barbara Rockefeller, who offers daily reports on fundamentals and technicals of the major currencies (www.rts-forex.com).
Most charting programs have indicators pre-installed: Bollinger Bands, moving averages, On Balance Volume, MACD, relative strength index (RSI), stochastics, etc. Some have programming languages as well. You can create your own trading algorithms, and even automate them. Cost can be about $50 to $100 per month. TradeStation’s is free, if you do a set number of trades per month.
Technical analysis can quantify and measure price and volume. Charts put this information in picture form. Technical analysis may not predict price action, but it can suggest trends. Even traders who insist on only trading off of fundamentals acknowledge that with so many people trading off of technical price points, they are valid, if for no other reason than so many people are using them.
In “Technical Analysis for Dummies,” Rockefeller describes many technical tools that can help you identify trends. “Spotting trends,” (below) shows a simple line chart of the S&P500 cash index. The blue line is a 13-day simple moving average that smoothes out the noise of daily volatility, giving you a better understanding of the prevailing trend.
As noted previously, Kaufman says software selection should be your last step. Perhaps he is forecasting what a neophyte trader might do when faced with the myriad of indicators or tools available in a basic software package if he or she has not yet settled on a tested approach to trading the markets. “Paralysis by analysis,” (below) provides a small sample of the various tools offered in a basic charting package. Each of the indicators in any software package can be helpful in some way in navigating markets, but a trader can get lost in the numerous indicators and end up frustrating his efforts by using too many or by not applying them in the correct manner.
EnsignSoftware, eSignal, NeoTicker, NinjaTrader, TradeStation and others can all create charts that even fundamental traders can value. Aside from standard OHLC bar charts, most programs offer volume and tick bar, candlestick and point-and-figure charts.
Many charting programs also have news links that provide a constant stream of free financial news, much like the free Google or Yahoo news pages you can set on your Internet browser. If you want specialized news, you will have to subscribe, which adds to your monthly overhead. The subscription news services that are relevant to the particular contracts you are trading usually can be interfaced with charting programs. But paralysis by analysis applies to having too much news to read, as well too many indicators to watch. So if you need news, try the free news your software vendor offers first.
There is a whole subset of charting programs that create trading signals for you. They can cost a few thousand dollars. TradeGuider, for example, uses volume to create its signals.
The type you need depends on how you trade. End of day prices are free (check the GTET for various types of data vendors), but if you trade frequently, you will want continuous live data. Many vendors offer free trial periods for short periods of time, and most of the charting programs can be installed quickly and almost painlessly. TradeStation will provide data directly from exchanges. When estimating costs, be sure to add on exchange fees, which can range from $5 to $70 per month.
In the past, brokerage and trading software packages were largely separate, but with cheaper execution costs and the ability to execute shorter-term strategies, it is possible to purchase an overall trading solution. Choose a broker where you can enter orders live using the fastest connection you can get. Speed may not be a priority for your strategy but all things being equal the fastest connection is preferred. Check to see if the broker can fill the order types you want to use. A safe cost estimate is $5 a round turn including exchange fees. Also, check to see if the broker has a 24/7 telephone order desk when (not if) your Internet connection or computer goes down.
Building your trading method
Kaufman says that most people use charting packages to confirm that what they’re doing makes sense. “You might see a sell signal on your chart. But the volatility is very low, so your chance of making money on trade isn’t good,” he says. “This might prompt you to put in a volatility filter to make sure the market was moving enough. The trick to using charting software is to have a concept to picture what you want to do,” Kaufman adds.
These programs have scores of well-known technical analytical tools. Both Kaufman and Rockefeller advise that you should develop a concept (moving average crossovers and regression channels, for example), then backtest using past price data.
Some charting programs, Ensign, NeoTicker and TradeStation, include programming languages that are pretty easy to use. You can create your own indicators and even automate your trading with them.
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 email@example.com.