Wouldn't it be great if you could devise a trading strategy, test it against historical data for five months, five years, whatever, and then let that system run on automatic for a while -- paper trading so you can see how it works? In fact, software lets you do just that has existed for years. Problem is, the programs have been so clunky that only hardcore programmers could use them. Or else -- as I talked about in a column in March -- the software was locked away in the backrooms of investment firms. Now analytical trading software is beginning to creep onto the Web. Whether that's good or not we can deal with in a moment. But the fact is, right now you can register with several Web sites and test drive strategy-developing software for free. Moreover, at least one online brokerage plans to make analytical trading a major part of its service package.
First, what exactly are analytical programs and how do they work? Many function a little like the stock screens I wrote about in June . To use them, you first devise a series of rules you think should govern your trading. An example might be: "I'll buy only stocks of optical-component companies with high double-digit earnings growth that are currently trading below their 50-day moving average." I'm only using stocks as an example. Different programs allow you to create trading strategies for futures, options and currencies. In all cases, you just fill in the blanks, as in a questionnaire, denoting all the criteria you wish to use. A stock screen will then spit out a list of companies that fit the bill. But analytical programs go a step further. They'll search for companies that met your criteria, say, two years ago. Then, acting as if they purchased shares of those stocks two years ago, they'll track the progress of the investment using historical market data. In that way, they're able to test whether your strategy would have made you rich or poor. The term for this is back testing. As a next step, analytical programs will paper trade stocks that meet your selection criteria. This is called forward testing. And here again, you get an ongoing view of how well your system works. Finally, in the course of your live trading, the best of these programs scan through terabytes of real-time market data and alert you when a trading opportunity arises -- as always, based on the rules you've defined. That's the gamut of things these programs can do for you. A couple of Web sites now offer pieces of this functionality for free. For example, the stock screen at CNBC allows you to build a fairly complex search that brings up a list of companies. In addition, a nice graph comes up to show you how well your strategy would have performed month to month over the past year. Another site, Tradetrek.com , actually picks stocks for you with its analytical software. And in that way the site is similar to siXer.cOm , EquityTrader and StockConsultant.com . All these free sites use analytical software to generate buy and sell signals. Tradetrek.com differs slightly in that it incorporates a back-testing feature that allows you to see how well the software has performed in the past. Just choose a date, click on one of the stock recommendations that appeared on that date and then click "next day." And you see whether the program's recommendation would have made or lost you money. (It would be nice if more financial Web sites were this forthcoming.) Tradetrek.com is free if you use delayed data. Subscriptions give you access to real-time data and cost $25 per month. AboveTrade.com goes further still by letting you devise and back test trading strategies for individual stocks. So let's say you choose America Online ( AOL). Tell the program how much of a gain you want each time you enter a long position. Let's say you'd like to make 4% on each trade. Now here's where AboveTrade.com gets a little cartoonish. You then choose from a handful of canned strategies. Each has a descriptive name, such as the "Cautious Dr. Trend" or the "Aggressive Major Bullmaker." Then you choose an industry analyst calculator that gives special weight to, say, interest rates or the sector your stock falls within, in this case the Internet sector. Press the "See Results" button and you see how well your strategy for the stock might have worked over the course of up to two years. Specifically, a graph of the stock comes up showing your suggested entry and exit points for the test period. If your strategy turns out to be a winner, you can look for parallels between how the stock charted in the past and how it charts currently and then trade accordingly. Devising even this sort of simplified strategy can be time consuming. The trading systems I built on AboveTrade.com invariably came back showing negative returns. Maybe that was just my luck. Fortunately, AboveTrade.com has a feature that shows you the winning strategies picked by other members. I discovered, for example, that a member's strategy, dubbed "AOL and asha," would have given me a 104% gain over the past year through Wednesday (vs. a 12.5% return if you had bought and held the stock over that period). This feature reminds me of the amateur stock recommendations you find at sites like ClearStation.com and iexchange.com . Except that instead of swapping stock recommendations, people at AboveTrade.com are able to swap trading strategies. It's all a lot of fun. But, as I hinted earlier, AboveTrade.com seems more like a toy than a serious application. For one thing, I have no idea what specific criteria "Aggressive Major Bullmaker" bases trading decisions on. For that matter, I wouldn't bet the house on a strategy spit out by the CNBC stock screen or the Tradetrek.com stock-tip engine, either -- not without doing a lot more due diligence myself.
Lots of companies market more serious analytical programs on the Net. The magazine Technical Analysis of Stocks and Commodities ( traders.com ) contains what's probably the most complete list available. The leader in this category has long been TradeStation from Omega Research. TradeStation has its own programming language, as well as an extensive list of canned strategies to choose from. The program's users have always been a close-knit subculture, like Airstream trailer owners. They meet at annual conventions and belong to user clubs throughout the country. And they actively sell or swap the trading strategies they've devised. Until recently, the complete TradeStation suite of programs would have cost you about $5,000. But sometime in September, Omega Research plans to merge with the Internet active-trader brokerage OnlineTrading.com . When that happens, TradeStation won't be sold as a stand-alone package. Instead, it will be integrated with OnlineTrading.com's execution platform, which takes a commission per trade and already contains the bells and whistles daytraders look for. The idea, of course, is that you can program in a trading strategy using TradeStation, then back test and forward test it. And when you're ready to go live, you just pull the trigger whenever your system spots an opportunity -- a nice package. And Omega Research co-founder Ralph Cruz believes he can count on TradeStation's 45,000 strong customer base to be among the first to migrate to the new service, which will be called TradeStation.com . "You could think of TradeStation as a CyBerCorp.com competitor," says Cruz. A popular daytrading brokerage, CyBerCorp.com has a professional-level execution platform that also includes an analytical program called CyBerQuant. CyBerQuant allows you to do real-time stock screening, but it doesn't back test the results. So will back testing and other sophisticated trading strategy development tools become part of every active trader's arsenal? Cruz believes leaving it to a computer to plan and execute your trades will take a lot of angst and uncertainty out of the job. "Traders now are overwhelmed with information," he says. "But deep down they realize that ultimately the greatest obstacle to their own success are their own emotions, specifically fear and greed. TradeStation is based on the premise that the best way to be successful is to isolate your emotions from your decision-making."