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Strategy Testing

Are Today's Futures Trading Software Programs Right for You?

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By: Louis B. Mendelsohn
President, Market Technologies

Computer power, previously limited only to large institutions, is now widely available to the trading public. No longer is a futures trader limited to relying solely on price charts, broker recommendations, or news events as the basis for making trading decisions. Nor must he or she be part trader, part programmer. Now, even a trader with a small account can use software to gain a more competitive edge in the futures markets, noted for their high risk, but substantial potential reward.

With an increasing number of traders embracing computer software, it's time to take a closer look at the recent evolution of trading software and to assess its impact on trading performance.

Until just a few years ago, two basic types of software trading approaches prevailed. Both had serious drawbacks which detracted from their effectiveness as trading tools.

The first type, known as "analysis" software, offered a broad choice of technical indicators. The major drawback to this approach was that it required traders to make subjective interpretations before arriving at a trading decision. By having to evaluate various conflicting technical indicators, traders could not develop and follow a disciplined and consistent trading strategy. Trading volatile markets without such discipline can be an invitation for disaster.

The second type, known as "system," or "black box" software, overcame this problem by incorporating "logic" into the software to generate exact trading signals at specific prices. A serious disadvantage here was that signals in black box software are based on undisclosed entry and exit rules intentionally kept secret from traders. And so, they had no control over their trading plans and were expected to follow the signals on blind faith. This secrecy and lack of understanding caused traders to second-guess the signals, which completely undermined the discipline needed for a sound trading strategy.

ProfitTaker changed all that. With its introduction in 1983, it launched a new generation of futures trading software. Through full disclosure of its technical indicators and completely revealed logic, ProfitTaker gives traders total control over their trading plans. ProfitTaker introduced a history tester, which enables traders to design and test personalized trading strategies under simulated trading conditions before traders actually risk capital. The history tester even automatically handles the "rollover" when a current month is about to expire. ProfitTaker performs these simulations and generates unemotional disciplined signals, based on individual trading strategies.

Since 1983, other software programs have been introduced. These programs have many of Profit Taker's features, including its strategy testing capability. This feature is now standard in futures trading software.

The big question is whether the current generation of software will live up to traders' expectations of increased profits. A look at the strengths and weaknesses of current software will help answer the question.

The strengths are obvious. Traders can now create specific trading models to suit their own trading styles and risk propensities. As market characteristics change, these models or strategies can be adjusted to reflect new conditions. This contrasts sharply with the "seat-of-the-pants" or "gut feeling" trading approaches still used by most non-computerized traders.

The weaknesses of today's trading software are more difficult to assess. Many existing packages, often referred to as "gray box" software, disclose only some of their entry/exit rules, while keeping others proprietary. Like the earlier "black box" approach, traders are prevented from completely understanding the trading signals. This lack of knowledge can lower confidence to act on the signals and consequently lessens discipline.

Another critical issue is copy protection, which creates unnecessary risks for traders. Frequently, copy protection schemes built into software cause software crashes, during which a trader cannot receive his trading signals and risks losing capital.

Finally, the most serious issue is the validity of the software testing process. Software developers and traders have become enamored with the brute force of computerized testing and "optimizing" of trading strategies. There is a tendency to think that the more technical indicators or entry/exit rules built into the software, the more profitable the trading. That is not necessarily true. The models "curve fit" to tested data, then fail to hold up under real time conditions. By keeping the trading simple and using as few indicators as possible, profitable and stable trading models can be found which uncover the general tone of the market.

These are some of the pros and cons that a trader needs to be aware of when considering technical software. Trading software is still more of an art than a science. These and other issues must be resolved before computerized trading can evolve to the point where a trader simply plugs in his computer, generates daily trading signals, and confidently plays golf while his trading account grows.

Louis Mendelsohn, president Market Technologies, Wesley Chapel, Florida, designs and tests neural trading systems for the financial industry.

 

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