Smart Investor: trading software roadtest

Smart Investor, November 2010

There is something wonderful about the idea of a piece of software that will sort out your investment needs. A black box, a charting system, a research tool – people differ in what they want from trading software, but have one common ambition: getting better returns for less effort with the assistance of technology.

But there are many different types of trading software available and they all do markedly different things. Getting the right product requires you to be very clear about what you want. This article suggests some key steps to make sure you get the package that’s best for you, and then get the best possible use out of it – if, that is, you need one at all.

To see the article as it ran click here: 22Nov_chartingp50-51 and 22Nov_chartingp48-49

[Subhead: What’s out there?]

Step one is understanding just what’s out there. At one extreme is the ‘black box’ system. You may see these advertised from time to time (or receive a cold call selling them) with remarkable promises of their track record and ability, but they generally don’t tell you how they come up with the recommendation. These things have a very bad name. We don’t recommend them and neither does ASIC, which puts its reasoning very succinctly. “If you rely on these programs, you put complete faith and trust in the skill and reliability of the programmers,” ASIC says in its public information on trading systems. “If their reasoning is wrong or if their program is unreliable, you won’t know and you will have no control. You will also not be able to properly assess the level of risk in the program, and whether it matches your own risk tolerance.”

ASIC recommends only buying these programs from people who hold an ASIC licence – you can check this through the databases available on ASIC’s web site – and warns specifically against promoters who promise high returns over a short period, do not disclose potential losses and risks, claim the program will make you a successful trader, provide examples of large profits made by investors using the program in the past, or who are based overseas.

There are, though, decent providers (including some based overseas) who may suit your needs provided you’re very clear on what they can and can’t do. None of the systems mentioned in this article are black boxes, because in every case you can dig in and find out how and why it has recommended whatever it’s come up with. But if you’re after something that will tell you what to buy and when to buy it, the closest reputable system to that goal is probably Share Wealth Systems and its SPA3 product.

With SPA3, you start out by telling the system what your risk profile is. You decide how much liquidity you want in your stocks, and how much you want to allocate between low, medium and high risk positions – there are defaults available if you want to be guided on this. Every day, you get SPA3 to scan the market and, if stocks are available that fit its methodology, it will create buy signals and tell you which of the high, low or medium risk positions they fit. It even tells you how much of your portfolio to invest. As time goes by, it will tell you when it thinks you should buy more, and when you should sell.

Some systems, like Pro Trader and OmniTrader, are sophisticated charting systems – as most products in this area are – but also offer buy signals in certain circumstances. In both of these cases, you can use the product to try a variety of charting techniques, and then get it to trigger buy and sell recommendations that fit with the approach that you’ve selected. Others are just charting programs – you can infer your buy and sell recommendations from what they show you, but they’re basically about the charts. Products like Bull Charts and, to an extent, Insight Trader fit into this category.

Still another camp is represented by Stock Doctor, which stands out for the fact that it is not primarily based on charting (though you can use it for that). Instead, this is a program that helps you with fundamental analysis – it will run any Australian stock through a series of criteria and help you do the research that suggests whether you should buy it.

[Subhead] Know what you want

With this range of product available, the next stage is pretty clear: know what you want. In fact, start by asking yourself the question: are you sure you really need a trading system at all? If you just want to build a portfolio of blue chip yield stocks and hold them for 20 years then you’re probably not going to get much out of a trading system. If you’re a believer in understanding the companies you invest in, knowing what they do and how they’re managed and the ins and outs of their industries, then most of these programs aren’t going to suit you either because their recommendations have nothing to do with those things – they are, in the main, generated by patterns in share price movement, totally without consideration of any external events that might have caused them. (You might, though, find merit in having a portfolio management system that tells you a bit more about the stocks you do own.)

If you want a system that will pretty much tell you what to do without having to get into the mechanics of why it’s decided it, and are happy to trust it despite it recommending some stocks you will never have heard of, then you will probably start out looking at Share Wealth Systems, since it will do this while also paying attention to your risk profile. Then again, if you’re looking to add zest to an existing portfolio of stock, this system probably isn’t for you as it’s better suited to the investment of a new block of cash from scratch.

If you are an experienced chartist who knows his Darvas Box from his Guppy models, and can work out your recommendations perfectly well from the charts you generate, then you’ll probably be looking at something like BullCharts. If you understanding charting but want some guidance on what the charts themselves mean in terms of solid recommendations, you’ll be looking at OmniTrader and ProTrader. ProTrader has a proprietary system called a Combo Scan which, for example, looks for stocks that have produced a breakout or a volume event; OmniTrader will produce signals within dozens of different trading strategies based on parameters you set.

And if you’re a fundamental investor looking for a toolbox to help you make your decisions, it will be Stock Doctor. But, there too, you’ll want to be sure that it’s going to provide you with information and support you can’t already get from your broker.

[Subhead] What do you need?

Do you want your program to act as a portfolio management tool too? Most of the programs in this article will help you, but it is a bigger feature on Stock Doctor, for example, than BullCharts, which is primarily about the charts themselves. Do you want your system to help you plan your trades, telling you when to get out as well as when to get in? Trading plans are key areas of ProTrader, OmniTrader and Share Wealth Systems, for example. The first two encourage you to set stop losses, so you will be pulled out of a trade if they fall a certain distance; in Share Wealth Systems, these things are automated anyway.

Another important area to be clear on is how much training and guidance you want. Share Wealth Systems – which, ironically, is the one system you could probably use fine with hardly any training if you really wanted to – offers excellent one-on-one webinars with a helpful instructor who will take control of your mouse remotely in order to show you around your system. OmniTrader has dozens of outstandingly slick and clear online tutorials (it’s an American system, so most of what it talks about by way of examples are US stocks, but that hardly matters). ProTrader, too, has strong videos and manuals. Others, while very clear, opt for the straightforward instruction manual approach. BullCharts really does require you to know what you’re doing before you get started: when we roadtested it for six weeks last year we found it full of exceptional charts reflecting the techniques of celebrated investor Alan Hull, for example, but that’s only useful if you have any idea what it means.

You may, too, value a sense of community with other users: many of these systems set up chatrooms, email coaching, tip sheets and newsletters which some will find helpful and others distracting.

[Subhead] Getting started and costs

It’s also useful to realize that some packages allow you to get started straight away with what you’ve got, while others require you to set up other accounts in order to get moving. OmniTrader and Insight Trader, for example, require you to set up an account with an external provider to give you the stock exchange data you will need each day – not complicated, but an additional cost. OmniTrader is probably the most sophisticated system on the market, tremendously powerful and detailed, but many of its strategies, such as Darvas boxes, require you to buy additional modules.

On this point, costs vary widely too. ShareFinder costs you A$2,995 – or A$3,990 for a version with CFD capability – plus a $71.50 monthly maintenance fee which includes the data supply, help desk and weekly training webinars; the support is terrific but you’re going to need to make all that money back before it makes sense to buy it. At ProTrader, you have a choice between Pro Trader membership, which includes software, data, education, market commentary and recommendations and costs A$2450 for the first 12 months with a A$660 annual renewal fee, or a package with the software, data and technical support only, at A$898 plus data fees. At OmniTrader, although the basic version (on end-of-day data) is US$495, a bundled version with a chart pattern confirmation module and strategy modules for Guppy GMMA2 and Darvas box strategies would cost US$1,634, or US$1,470 through Australian distributor Corporate Doctor, plus a data provider at about A$33 a month. Stock Doctor will cost you A$1,895 for the first 12 months, including software, email and phone coaching, newsletters and tip sheets, with various longer-term and instalment payment options. The systems with less support and training cost less: BullCharts $795 for the software and $352 per year for the data. Insight Trader is $795, or $1295 for a trading package including 10 hours of training, a trading plan and database manager.

One other consideration is whether you want a live data feed or end of day data: some systems allow you to do both, but live data will cost you more to get. Most non-professional investors opt for end of day data feeds and review them in the evening or morning; they then send instructions to their broker to act on the signals when the market opens, or after an hour or two has passed in order to let the opening volatility die down. One thing you’ll have to get used to with this approach is that the price a system suggests may not be the price you get, because the market may well move in the meantime – whether to your benefit or detriment.

Next, think about how much time you can devote to using these systems. You can spend all your day in a program like OmniTrader and still not figure out all its possibilities, which is fine, if you have time to do so. Be realistic about what you will really do. If you can spare 20 minutes at the end of the day to upload the latest data and recommendations (nearly all programs require you to do this) and have a think about whether to act on the results, that’s probably going to mean a different system than if you can sit at home for several hours a day and make trading your main job.

Whatever system you opt for, it’s well worth spending some time – maybe a month – doing nothing but paper trading while you figure everything out. For example, a system may trigger a multitude of buy signals, but after a while you are notice a few nuances about them: that you shouldn’t just blindly follow a recommendation but look at what has triggered it and whether the same sort of signal has worked in recent history. You will also want to be clear on what your strategy is going to be. Will you follow the technical recommendations absolutely? Or will you use some fundamental common sense too – not buying a stock because it’s triggered a signal when you know for a fact the whole sector’s about to face a major regulatory overhaul, for example?

All these programs will be useful for some people. But don’t aim too high without first having figured out what you want to do, and at least the basics of the market you hope to make money from. You can garner a strong knowledge of the share market from courses such as those hosted by the Australian Securities Exchange; only after you know what you’re doing can you really decide if your investment experience will be enhanced by these products. Once more, ASIC says it best. “Find out about shares and the market before you spend a lot of money on fancy tools you may never use. Imagine if a friend suddenly decided to be a carpenter and told you he was going to spend $15,000 on new tools before he had even tried to make a bread board.”

BOX: What’s new?

Last year Smart Investor roadtested five systems and then reported back on our experience. They continue to be tweaked, modified and improved.

For example, at Share Wealth Systems, its SPA3CFD system – actually launched in 2008 – is gaining traction. This offers an interesting take on CFDs: it is designed to control the amount of leverage in a CFD portfolio by taking that control away from the CFD provider. Instead, the system trades a mixture of stocks and CFDs in a single portfolio in order to bring down the leverage of the overall portfolio. Clients can leverage at 1.5, two 2.5 or three times the value of the portfolio, which the manufacturers consider more prudent than the leverage people tend to take on with CFD providers. “This would be the number one reason 90% of people who trade CFDs fail,” says Share Wealth Systems’ Sean Baker. “They’re just provided with far too much leverage and they blow themselves up.”

At BullCharts – apart from capitalizing their C in the last year – the main development has been the launch of alerts, advanced portfolio management and a trade planner. This brings the product more into line with the others in this article. This has come without any increase in the sales price.

OmniTrader continues to launch new modules all the time. Recent examples include a module geared towards the Guppy model of multiple moving average trends (GMMA2), a set of systems based on volume indicators, and an upgrade of the whole system in 2010. This includes a new easy view approach (though they do insist on calling it EZ-view), multiple timeframe candles, and advanced line studies and drawing tools.

BOX: My experience

When I was asked to roadtest a range of trading systems for Smart Investor last year, I found myself facing a number of challenges – not least the IT issues of running five such systems simultaneously on a creaking PC. That, at least, will not be an issue for most users (and if you have bought five different systems, you really do need a rethink).

The first thing that struck me was what an involved and arcane part of the market charting can be. It was immediately clear to me that most of the systems I was trying would be of no use unless I knew what I was looking for, and so I set to work. Anyone can understand crossover strategies, reversals, breakouts and trending with a bit of effort and application. But before long I found myself in a swamp of Darvas boxes, fibonacci indicators, turtle strategies, Hurst cycles and Guppy multiple moving average trends. There is simply no limit to how much you can read and learn about interpreting the patterns of share price and market movement, and it is easy to be overwhelmed. My first decision was to understand the basics and focus on a couple of the more celebrated strategies rather than make any pretence that I had mastered the whole lot.

A second challenge was to let a system do what you have bought it to do: make cold and unromantic judgments based on nothing but a pattern. I’ve been interviewing fundamental-based fund managers for a decade or so and that’s the received wisdom I bring to stock selection: that price or momentum are only part of a picture that includes people, industries, consumer behaviour and global capital flows. Trading systems couldn’t give a flying fig about any of those things. “Buy that? Are you mad?” I would ask my system as Share Wealth Systems put me into a stock I’d never heard of called Jabiru Mining, and OmniTrader generated a buy signal on NAB as the US banking sector was sinking. A key decision to make is whether you’re going to trust a trading system and let it do its thing or temper its recommendations with the context you know about the company. There’s a liquidity call to make too: some of the recommendations that came out of these systems were for obscure microcap companies that brought a natural queasiness to someone trained to believe you need to understand a company and its management before you contemplate buying it.

Trading systems require you to develop a daily routine. For me, it was to run all the systems about three hours after the market close, by which time all the various data feeds were ready. I would set the updates to run, go and make a cup of tea, then come back and sift through their recommendations. I would then set my buy and sell orders to take effect at the opening the following morning.

That said, at first I was only paper trading, and was swiftly glad I had done so. You might think you understand a system, but you only really understand it once you’ve got a few things wrong using it and learned from those mistakes. It took a month to be confident I knew not only what the systems were telling me but why it was doing so and how to interpret it.

And did it work? In the short time I tested the systems all of them generated positive returns, but during a period when the market did too. There were successful calls I would never possibly have imagined myself – a ProTrader recommendation to buy NRW Holdings triggered a 44% return in five weeks. There were plenty of duds, too, although the process was an education in the importance of a stop loss (a lesson I have taken back to conventional share investment).

In most cases I was impressed by the commitment to risk management and trade planning, and I got a sense of the addictive intricacy of finding opportunity in waves and lines. The experience did not convert me to a chartist. But now I understand the appeal.