Tool Box. Software, Scanning & Testing

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Introduction

Like any professional, to be a profitable trader you need the right tools, these tools are out there to be bought or for free use and we'll look at some of these tools below. Your toolbox must allow you to research the markets you want to trade (FX, Stocks, Commodities etc...), have access to good software packages, be up to date about breaking news and have access to a broker

You should have a solid understanding of the market, reversal patterns, consolidation patterns, trendlines, stochastics, volume levels, support and resistance levels etc. before you begin trading. Profitable traders have a firm grasp of technical analysis and use this knowledge to develop a trading plan. Make sure you utilise this whole course to grasp this knowledge, before delving into The Traders Toolbox.

About half of the trades done on exchanges are done by computers (c.2010); programmers set the rules and the computers follow them. The computers don’t send up prayers to the heavens so a stock will turn around, nor do they get smug when they take profits. They follow the trading rules diligently and consistently. Profitable traders learn how to trade like computers, in a disciplined and consistent manner, and always stick to their trading plan.  We'll talk about trading plans and strategies in a later module, but we will touch on automated trading below.

Software Packages

We're not here to recommend platforms, just to make you aware of all your options. There are a variety of trading software packages available, and on many different platforms. In fact they even allow automated trading and robots and come with free online trading demos. Some packages will charge and other are free - you obviously get what you pay for.  Packages like Tradestation and MetaTrader4 are the maybe the most popular pay platforms, while Stockcharts.com is maybe the best low cost ones.  The pay packages will supply real-time data, while the free ones will have 15/20 minutes delay.  Brokers will have their own trading platforms with real-time data and come with various facilities. Other packages I've found are ProRealTime.com which will give you free scans for end of day data as does FreeStockCharts.com

The most important thing your software must do is Chart.  As well as chart, most of these packages allow traders to add technical analysis to charts, set filters to scan for a trade (i.e, find trending markets by setting technical indicator parameters), back test your trading strategy, set up a demo account and some will allow automated trading after you set up rules.  The subscription based platforms will also allow you to execute trades without logging on to your broker's software package.  Obviously your brokers own platform allows execution too.

Market Screening/Scanning

Most of the above packages will allow the screening of stocks, markets, forex, commodities etc...  Screening or scanning is important to choose the correct market to trade in.  There are tens of thousands of market out there and it would take an age to find the best market to trade that best fits your trading set up.

Scans are easy to write and absolutely essential to trading. You need to be able to find stocks with the exact set up for your trading strategy.  Some packages have pre-set scans, derived from the most popular searches and some will identify whether to go long or short (MarketClub) and supply trading and news alerts (eg. Equity Feed).  Most of these platforms will also draw charts with technical indicators.

Stockcharts.com. has good looking charts and they also have a fast and powerful scanning engine. You can use their pre-defined scans or create your own from scratch.  We'll go through a typical stockcharts.com scan below.  Here we'll scan for a Swing Trade to go long (a trade entering a consolidation period within the current up trend) that pulls back to between the 10 and 30 period SMA (or the trader action zone - TAZ - see swing-trade-stocks.com).  So in essence we are buying the dips.

Once you have clicked on the scanning page, click on "Advanced user interface" at the bottom of the page. In the scan expression box paste in the following:

[type = stock] and [country = us] and[daily ema(60,daily volume) > 150000] and
[daily high < yesterday's daily high] and
[yesterday's daily high < 2 days ago daily high] and
[sma(10, close) > ema(30, close)]and
[daily close > daily ema(30,daily close)]and
[daily close < daily sma(10,daily close)]and
[daily close > daily sma(200,daily close)]and
[weekly sma(10,weekly close) > weekly ema(30,weekly close)]and
[ADX Line(10) > 20.0]and
[close >= 5]

Can you tell what the components of the scan mean? In the first line we are looking for US stocks with average volume of at least 150,000. The next two lines we are finding stocks that have consecutive lower highs. Then you have the moving average lines in the scans that find stocks that have moved into the TAZ.

We then use the ADX Indicator to make sure we find stocks that are trending. The next line makes sure that the stock is in an uptrend on the weekly chart. Finally we pick stocks with a closing price of at least 5 dollars on the long side (don't trade penny stocks! They are too volatile).

Now click "Add/modify the current scan" to save the scan.  Once it has been saved you need to go back and select your favourite scan from the drop down menu.  Select our scan and click "scan".  A whole list of stocks that meet our criteria arrive.  

Others scanners include - Market Club, Equity Feed and StockFetcher.  We won't look at how to scan on these platforms, but they each have online tutorials

Back Testing

Back testing is a key component within your trading strategy and set up. In essence it's using historical data and trades that would have occurred in the past using rules defined by a given strategy. The result measures the effectiveness of the strategy. Using this data, traders can optimize and improve their strategies, find any technical or theoretical flaws, and gain confidence in their strategy before applying it to the real markets.

Software

There are a few packages that allow traders to backtest. I won't mention all here, but some that allow backtesting include Tradedecision.com, Metastocks, MetaTrader 4, Ninja Trader and Amibroker.com. The former two are high end trading systems and the later is less expensive. You can manually back test your system - see our lesson in Mod 10. Testing your system - Manually. Most packages will record the following info:
  • Net Profit or Loss - Actual and Percentage
  • Time frame - Past dates in which testing occurred.
  • Markets (stocks, FX, Commodities etc...) that were included in the backtest.
  • Volatility measures - Maximum percentage upside and downside.
  • Averages - Percentage average gain and average loss, average bars held (average length of a trade).
  • Exposure - Percentage of capital invested (or exposed to the market).
  • Ratios - Wins-to-losses ratio.
  • Annualized return - Percentage return over a year.
  • Risk-adjusted return - Percentage return as a function of risk.
Typically, back testing software will have two screens that are important. The first allows the trader to customize the settings for backtesting. These customizations include everything from time period to commission costs. Here is an example of such a screen in AmiBroker:

Typical Back testing Screens

Things to Remember when Back testing

There are 10 main things to remember when backtesting:
  1. Time Frame - back test over a long time frame that includes several different types of market conditions. This is important because if you trade the trend, you don't want to be testing only a range. The results won't match your trading strategy.
  2. Similar Markets - As a general rule, if a strategy is targeted towards a specific genre of market (eg. tech stocks) limit the "universe" (markets that were included in the back test) to that genre. If you're looking to find out how the system trades
     
    in a broad selection of markets, back test a wide universe.
  3. Volatility - Volatility measures are extremely important to consider in developing a trading system. This is especially true for leveraged accounts, which are subjected to margin calls if their equity drops below a certain point. Traders should seek to keep volatility low in order to reduce risk and enable easier transition in and out of a given stock.
  4. Hold Trades for longer - The average number of periods (bars) that a trade holds for in a market is also important to watch when developing a trading system. Although most back testing software includes commission costs in the final calculations, that does not mean you should ignore this statistic. Trading strategies that churn numerous trades can fall subject to slippage and high commissions. Holding trades for longer cuts these commission cots
  5. Reduce Risk - Keep exposure below 70% in order to reduce risk and enable easier transition in and out of a given stock.
  6. The average-gain/loss statistic, combined with the wins-to-losses ratio, can be useful for determining optimal position sizing and money management. Traders can take larger positions and reduce commission costs by increasing their average gains and increasing their wins-to-losses ratio.
  7. The Returns must add up - Annualized return is important because it is used as a tool to benchmark a system's returns against other investment vehicles. It is important not only to look at the overall annualized return, but also to take into account the increased or decreased risk. This can be done by looking at the risk-adjusted return, which accounts for various risk factors.
  8. Mimic your Brokerage System and be accurate and truthful - Many back testing applications have input for commission amounts, round (or fractional) lot sizes, tick sizes, margin requirements, interest rates, slippage assumptions, position-sizing rules, same-bar exit rules, (trailing) stop settings and much more. To get the most accurate back testing results, it is important to tune these settings to mimic the broker that will be used when the system goes live.
  9. Don't Over-Optimise. Don't be drawn into over-optimising your results.
  10. Open a Demo Account too. Past performance is not indicative of future results. Be sure to test your back testing system with a demo account first before go live.

To Sum Up

Back testing is an important aspects of developing a trading system. If created and interpreted properly, it can help traders optimize and improve their strategies, find any technical or theoretical flaws, as well as gain confidence in their strategy before applying it to the real world markets.

More...

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Introduction

Like any professional, to be a profitable trader you need the right tools, these tools are out there to be bought or for free use and we'll look at some of these tools below. Your toolbox must allow you to research the markets you want to trade (FX, Stocks, Commodities etc...), have access to good software packages, be up to date about breaking news and have access to a broker

You should have a solid understanding of the market, reversal patterns, consolidation patterns, trendlines, stochastics, volume levels, support and resistance levels etc. before you begin trading. Profitable traders have a firm grasp of technical analysis and use this knowledge to develop a trading plan. Make sure you utilise this whole course to grasp this knowledge, before delving into The Traders Toolbox.

About half of the trades done on exchanges are done by computers (c.2010); programmers set the rules and the computers follow them. The computers don’t send up prayers to the heavens so a stock will turn around, nor do they get smug when they take profits. They follow the trading rules diligently and consistently. Profitable traders learn how to trade like computers, in a disciplined and consistent manner, and always stick to their trading plan.  We'll talk about trading plans and strategies in a later module, but we will touch on automated trading below.

Software Packages

We're not here to recommend platforms, just to make you aware of all your options. There are a variety of trading software packages available, and on many different platforms. In fact they even allow automated trading and robots and come with free online trading demos. Some packages will charge and other are free - you obviously get what you pay for.  Packages like Tradestation and MetaTrader4 are the maybe the most popular pay platforms, while Stockcharts.com is maybe the best low cost ones.  The pay packages will supply real-time data, while the free ones will have 15/20 minutes delay.  Brokers will have their own trading platforms with real-time data and come with various facilities. Other packages I've found are ProRealTime.com which will give you free scans for end of day data as does FreeStockCharts.com

The most important thing your software must do is Chart.  As well as chart, most of these packages allow traders to add technical analysis to charts, set filters to scan for a trade (i.e, find trending markets by setting technical indicator parameters), back test your trading strategy, set up a demo account and some will allow automated trading after you set up rules.  The subscription based platforms will also allow you to execute trades without logging on to your broker's software package.  Obviously your brokers own platform allows execution too.

Market Screening/Scanning

Most of the above packages will allow the screening of stocks, markets, forex, commodities etc...  Screening or scanning is important to choose the correct market to trade in.  There are tens of thousands of market out there and it would take an age to find the best market to trade that best fits your trading set up.

Scans are easy to write and absolutely essential to trading. You need to be able to find stocks with the exact set up for your trading strategy.  Some packages have pre-set scans, derived from the most popular searches and some will identify whether to go long or short (MarketClub) and supply trading and news alerts (eg. Equity Feed).  Most of these platforms will also draw charts with technical indicators.

Stockcharts.com. has good looking charts and they also have a fast and powerful scanning engine. You can use their pre-defined scans or create your own from scratch.  We'll go through a typical stockcharts.com scan below.  Here we'll scan for a Swing Trade to go long (a trade entering a consolidation period within the current up trend) that pulls back to between the 10 and 30 period SMA (or the trader action zone - TAZ - see swing-trade-stocks.com).  So in essence we are buying the dips.

Once you have clicked on the scanning page, click on "Advanced user interface" at the bottom of the page. In the scan expression box paste in the following:

[type = stock] and [country = us] and[daily ema(60,daily volume) > 150000] and
[daily high < yesterday's daily high] and
[yesterday's daily high < 2 days ago daily high] and
[sma(10, close) > ema(30, close)]and
[daily close > daily ema(30,daily close)]and
[daily close < daily sma(10,daily close)]and
[daily close > daily sma(200,daily close)]and
[weekly sma(10,weekly close) > weekly ema(30,weekly close)]and
[ADX Line(10) > 20.0]and
[close >= 5]

Can you tell what the components of the scan mean? In the first line we are looking for US stocks with average volume of at least 150,000. The next two lines we are finding stocks that have consecutive lower highs. Then you have the moving average lines in the scans that find stocks that have moved into the TAZ.

We then use the ADX Indicator to make sure we find stocks that are trending. The next line makes sure that the stock is in an uptrend on the weekly chart. Finally we pick stocks with a closing price of at least 5 dollars on the long side (don't trade penny stocks! They are too volatile).

Now click "Add/modify the current scan" to save the scan.  Once it has been saved you need to go back and select your favourite scan from the drop down menu.  Select our scan and click "scan".  A whole list of stocks that meet our criteria arrive.  

Others scanners include - Market Club, Equity Feed and StockFetcher.  We won't look at how to scan on these platforms, but they each have online tutorials

Back Testing

Back testing is a key component within your trading strategy and set up. In essence it's using historical data and trades that would have occurred in the past using rules defined by a given strategy. The result measures the effectiveness of the strategy. Using this data, traders can optimize and improve their strategies, find any technical or theoretical flaws, and gain confidence in their strategy before applying it to the real markets.

Software

There are a few packages that allow traders to backtest. I won't mention all here, but some that allow backtesting include Tradedecision.com, Metastocks, MetaTrader 4, Ninja Trader and Amibroker.com. The former two are high end trading systems and the later is less expensive. You can manually back test your system - see our lesson in Mod 10. Testing your system - Manually. Most packages will record the following info:
  • Net Profit or Loss - Actual and Percentage
  • Time frame - Past dates in which testing occurred.
  • Markets (stocks, FX, Commodities etc...) that were included in the backtest.
  • Volatility measures - Maximum percentage upside and downside.
  • Averages - Percentage average gain and average loss, average bars held (average length of a trade).
  • Exposure - Percentage of capital invested (or exposed to the market).
  • Ratios - Wins-to-losses ratio.
  • Annualized return - Percentage return over a year.
  • Risk-adjusted return - Percentage return as a function of risk.
Typically, back testing software will have two screens that are important. The first allows the trader to customize the settings for backtesting. These customizations include everything from time period to commission costs. Here is an example of such a screen in AmiBroker:

Typical Back testing Screens

Things to Remember when Back testing

There are 10 main things to remember when backtesting:
  1. Time Frame - back test over a long time frame that includes several different types of market conditions. This is important because if you trade the trend, you don't want to be testing only a range. The results won't match your trading strategy.
  2. Similar Markets - As a general rule, if a strategy is targeted towards a specific genre of market (eg. tech stocks) limit the "universe" (markets that were included in the back test) to that genre. If you're looking to find out how the system trades
     
    in a broad selection of markets, back test a wide universe.
  3. Volatility - Volatility measures are extremely important to consider in developing a trading system. This is especially true for leveraged accounts, which are subjected to margin calls if their equity drops below a certain point. Traders should seek to keep volatility low in order to reduce risk and enable easier transition in and out of a given stock.
  4. Hold Trades for longer - The average number of periods (bars) that a trade holds for in a market is also important to watch when developing a trading system. Although most back testing software includes commission costs in the final calculations, that does not mean you should ignore this statistic. Trading strategies that churn numerous trades can fall subject to slippage and high commissions. Holding trades for longer cuts these commission cots
  5. Reduce Risk - Keep exposure below 70% in order to reduce risk and enable easier transition in and out of a given stock.
  6. The average-gain/loss statistic, combined with the wins-to-losses ratio, can be useful for determining optimal position sizing and money management. Traders can take larger positions and reduce commission costs by increasing their average gains and increasing their wins-to-losses ratio.
  7. The Returns must add up - Annualized return is important because it is used as a tool to benchmark a system's returns against other investment vehicles. It is important not only to look at the overall annualized return, but also to take into account the increased or decreased risk. This can be done by looking at the risk-adjusted return, which accounts for various risk factors.
  8. Mimic your Brokerage System and be accurate and truthful - Many back testing applications have input for commission amounts, round (or fractional) lot sizes, tick sizes, margin requirements, interest rates, slippage assumptions, position-sizing rules, same-bar exit rules, (trailing) stop settings and much more. To get the most accurate back testing results, it is important to tune these settings to mimic the broker that will be used when the system goes live.
  9. Don't Over-Optimise. Don't be drawn into over-optimising your results.
  10. Open a Demo Account too. Past performance is not indicative of future results. Be sure to test your back testing system with a demo account first before go live.

To Sum Up

Back testing is an important aspects of developing a trading system. If created and interpreted properly, it can help traders optimize and improve their strategies, find any technical or theoretical flaws, as well as gain confidence in their strategy before applying it to the real world markets.

More...

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