Monday, August 15, 2011
A Perfect Time to Stress-Test Strategy
TradeStation integrates a powerful new technique for testing your trading theories in real markets.
If polishing up your theoretical trading models, rather than trading, was the most profitable use of your time in the last few weeks, TradeStation has just the product for you.
The sophisticated online broker last week integrated what it calls a Walk Forward Optimizer into its trading platform. Walk-forward analysis is a powerful technique that allows a trader to see how well a forecasting model works, by comparing its projections to historical data in a very precise manner.
TradeStation (http://www.tradestation.com), winner of Barron’s 2011 Online Broker Survey, acquired South Africa’s Technovest in June 2010, and hired its CEO, Wouter Oosthuizen, to bring the Internet-based financial technology he’d developed onto its latest downloadable platform, TradeStation 9.0. The Walk Forward Optimizer, or WFO, is designed to tell a trader whether his strategy will be reliable in practice. It automates a model-testing process that would be incredibly time-consuming if done manually. The Electronic Investor was given a late-beta demonstration of the tool courtesy of Oosthuizen, who is now a senior software engineer at TradeStation.
How does the WFO work? Let’s say you have 12 months of data on which you’d like to test your strategy. You might first focus solely on how your system works over the first four months of historical data, tweaking inputs, or parameters, to get the best possible result. These inputs might include anything, from a sharp move up, to insider transactions. You’d then “walk forward” to include a new month of data and see how your model works under the new conditions. Eventually, you’d progress through the whole 12 months, tweaking as you go. An actual walk-forward test would involve a lot more data, and multiple tests over the same set to get your trading model right.
The analysis calculates five sets of pass/fail evaluation criteria: overall profitability; correlation between in-sample (the development of your model) and out-of-sample (the actual test) data, which is also known as walk-forward efficiency; consistency of profits; distribution of profits; and maximum drawdown. Prior to running a WFO, the user decides on what the various thresholds are for passing or failing. Once that’s done, the WFO runs on multiple sets of data. It all gets done surprisingly quickly. Obviously, a “failed” reading means that strategy isn’t very robust and a “pass” means that it is. You can look at 3D graphs to help you analyze the results.
TradeStation has a video explaining this new feature on its QuickTips page.
The system can also do sensitivity analysis, which considers the effect of an individual parameter, say a moving-average crossover, on the model. By varying the weighting of a parameter, a trader can identify individual problems and evaluate the profitability of the model under different parameter weightings. It also provides distribution analysis that lets you display a variety of graphs comparing specific performance values against underlying market criteria. You can, for example, look at trades placed at specific times of day to see when the strategy is most successful.
This process can be highly technical; I didn’t run across most of the particulars until my second year of graduate work in econometrics. But you don’t have to understand all the nuts and bolts to be able to use this tool.
Oosthuizen says, “We don’t know of any other broker that has walk-forward analysis incorporated into its platforms. We believe the TradeStation Walk Forward Optimizer is a real game-changer for strategy traders, offering the ultimate strategy-trading stress-testing tool.”
MARKETSMITH GOES MOBILE. The company, which produces an incredibly flexible stock screening and charting tool, gave Barron’s an exclusive look at its new iPhone and iPad apps. We reviewed MarketSmith’s browser-based service, which runs $999 annually, earlier this year ("Two New Ways to Make Money,” April 11, 2011). Subscribers can use any of these platforms for no additional fee.
We like the iPad app, which is best viewed in landscape mode; the iPhone version is just too cramped for our aging eyes. MarketSmith (http://www.marketsmith.com) is a graphics-intensive approach to analyzing stocks and mutual funds, blending technical and fundamental stock data as well as proprietary ratings and rankings. The graphs look great on the iPad.
Subscribers can search the universe of stocks and flag those of interest on the go, then review the list in more detail on their desktop. This is a “light” version of the desktop application, but it allows you to perform screens and view complex charts when you’re mobile, and perform more complicated analysis once you’re back at your home base.
The firm’s president, Scott O’Neill, notes that “when a market gaps up or, as mostly recently, gaps down, a mobile application that helps keep investors grounded in the facts is invaluable to their profitability and peace of mind.”
You can access a two-week trial version of MarketSmith, including the mobile apps, for $19.95. The trial offer also includes product coaching so you can learn how it works before paying for the full year. If you want to check it out without laying out any money, there is a free three-day trial available as well.
GETTING OUT BEFORE THE FALL. SmartStops (http://www.smartstops.net), a service that calculates stop-loss targets and generates signals for re-entering a position, just launched a feature called the Market Risk Barometer. It measures the risk posed by components of an index or industry against its recent risk history. It’s calculated by dividing the current percentage in an above-average risk state to the 100-day moving average for that industry or index. A value of 1 or higher indicates a risk higher than the 100-day moving average.
Not surprisingly, every industry and index tracked by the new barometer was well above 1.0 when we reviewed the new tool on Aug. 8. It was alarming. Ninety-seven percent of the Dow Industrials were considered “above average risk,” while the barometer measured a whopping 1.81. Ouch.
A WILD WEEK: Online brokerage giant TD Ameritrade reported some notable occurrences during the 635-point drop in the Dow on Aug. 8. The firm’s trading volume exceeded the records set in the flash crash; previous records were shattered for options and futures, and mobile usage surged 29% from the previous week.
Published in Barron’s Online, August 11, 2011
Saturday, July 30, 2011
Trefis Now Available on E*Trade
Customers can tap into the novel research service that updates stock valuations based on changes in revenues and earnings. Plus, hedge fund Citadel turns up the heat on E*Trade management.
Investors who analyze fundamentals, by poring over a company’s balance sheet and income statement for clues to changes in its stock valuation, should take a look at Trefis. The firm provides a quick view of what a company does to earn its money, and whether it’s worth its current price.
Trefis (http://www.trefis.com) opened in 2010, and this month has partnered with E*Trade (http://www.etrade.com), integrating its basic service into the online broker’s Website. Christopher Larkin, a senior vice president of retail trading and client services at E*Trade, says, “Trefis is going to help our customers understand how a company’s product impacts the stock price.” Larkin says E*Trade emphasizes the importance of understanding the drivers of a stock price, and believes that Trefis (see “DIY Value Analysis,” Aug. 16, 2010) is a great educational resource.
Trefis tracks technology, media, telecom, consumer, retail, automotive, financial services and energy companies, and plans to expand to other industries such as pharmaceuticals, biotechnology and industrials. It also intends to cover companies listed on non-U.S. exchanges. It currently models the stock prices of 187 U.S. companies.
A Trefis-generated graphic will appear in the right-hand column of the display when an E*Trade customer looks at a company the research outfit covers. This snapshot also shows some fundamental data, a small chart, and news headlines for the stock.
Larkin says, “Customers are demanding more ways to interact with data, and we think Trefis did a good job from a visual standpoint.” If, for example, you want a quote for Apple (ticker: AAPL), Trefis’ graphic displays the stock price its model calculates, along with the percentage that each of the firm’s product lines contributes to that price. For Apple, Trefis estimates a stock value of $510 per share, which is about 32% higher than last Wednesday’s close. Its model calculates that almost 54% of Apple’s market value is driven by iPhone sales, and about 12% from the iPad.
The model components, developed by a team of MIT Sloan School of Management grads, can be explored by clicking on the graphic and playing around with the assumptions that have been built in by Trefis analysts. You can change price and marketshare forecasts for product lines, and see how that affects the stock-price estimate.
The Trefis share price is a combination of forecasts for a company’s products and other revenue sources. The forecasts calculate future revenues, costs and cash profits, the latter of which is discounted to the present using common Wall Street valuation methodologies.
Trefis updates its models at least every quarter, when earnings are announced, and revises its thinking along the way. It also updates whenever there is a meaningful event, such as a merger, acquisition, divestiture or product launch.
You can access this information from Trefis’ Website if you aren’t an E*Trade customer; a basic membership is free. In addition, you can play with the model on E*Trade’s Website without logging in.
As a data junkie and student of econometrics, I had a great time experimenting with the Trefis forecasting models. They’re very interactive and can help an investor who might not have the time to slice and dice annual reports and Securities and Exchange Commission filings to get a look under the hood of publicly traded firms.
If you want more, including access to the Trefis community so you can trade modeling ideas and see what others are predicting, you can subscribe to Trefis Pro for $14.95 per month, or $149 per year. There is a free two-week trial available for the Pro service, although you do have to enter your credit-card number to qualify.
E*TRADE IN PLAY? The online broker last week got attention for other reasons. Chicago hedge-fund Citadel, which owns nearly 10% of E*Trade Financial (ETFC), disclosed it was unhappy with the firm’s performance and management, and would like it to consider selling itself, among other options.
DO IT YOURSELF: TradeKing just launched TradeKing API, a set of technical-programming instructions that allows you to write your own trading application, or app, that ties into your account. It can also bring in applications and Websites from other developers to customize the appearance and functionality of your brokerage experience.
While an API (application-programming interface) allows you to create your own system, it’s more likely that developers and technology partners will create apps that can customize your trading environment. TradeKing refers to the launch as “a whole new avenue to deliver greater choice for the firm’s more than 250,000 clients,” but it’s also a way to bring data and content to the customers who want it.
Most third-party applications that tie into other brokers (among them E*Trade, Interactive Brokers, MB Trading, TradeStation, TD Ameritrade and OptionsHouse—see “Here Come the Third-Party Apps,” Aug. 9, 2010) require an additional fee. For instance, trading-automation service CoolTrade (http://www.cool-trade.com), which can execute trades via all brokers mentioned here, costs $3,990 per year for a subscription.
LIGHTSPEED BUYS SOME OPTIONS: Lightspeed Financial, which focuses on professional retail traders and institutions, has expanded its options-trading technology by buying Chicago-based Greenmoor Financial Group. Greenmoor (http://www.gfgtrading.com) publishes Green Trader, its proprietary front-end trading technology. The system includes an order-execution and management module that provides both simple and complex option execution. The Green Trader suite also includes tools that assist customers in identifying trading opportunities using client-specific parameters. Its Trading Opportunities Software, or TOS, includes algorithms that can identify market movers and changing market conditions.
Lightspeed (http://www.lightspeed.com) will offer the Green Trader front-end to clients, and also acquire Greenmoor’s registered broker-dealer business, Greenmoor Financial. Lightspeed mostly focuses on trading stocks, but CEO Stephen Ehrlich recognizes the opportunity to boost his customers’ options-trading. Ehrlich says: “Our existing customers are increasingly turning to this burgeoning asset class to enhance their trading strategies—whether it’s to hedge a position or to generate income. As such, we are committed to expanding our footprint in this important segment of the market.”
Published in Barron’s, July 25, 2011
Saturday, July 16, 2011
Clearing Up Cost-Basis Confusion
New IRS rules for cost-basis reporting are here. That means headaches, and opportunities for brokerages that can automate the task.
The first phase of the IRS’ revised cost-basis reporting rules—requiring brokers and investment managers to report not only the total proceeds from an investment sale, but also the amount paid for it—is under way, and is already prompting some rethinking. Since our readers have identified the tax switch as a key concern, we thought it was a good time to describe what’s up. But first, a little background.
The initial phase went into effect at the start of this year, covering stocks purchased after Jan. 1. For 2012, brokers will have to report similar information to the IRS about mutual-fund sales and, in 2013, the program will be expanded to options and fixed-income. Any position opened prior to Jan 1, 2011, is subject to the previous rules: You have to voluntarily report the cost basis on your tax returns.
Scivantage (http://www.scivantage.com), publishers of Maxit cost-basis reporting systems, is one of the software providers working with online brokers to keep track of transactions and other factors that affect cost-basis calculation. On its behalf, Celent, a research and consulting firm, published a report entitled, “Cost Basis Reporting: Where Are We Now?” in late June. A copy is available at http://info.scivantage.com/CostBasis-ReportingCelentReport6-2011-Download.html.
The report says many brokers may have panicked in trying to meet the IRS mandate. Isabella Fonseca, research director of wealth management at Celent and co-author of the study, says the regulations, “were significantly more complicated than firms had anticipated. The rush to meet the government’s requirements has led to short-term solutions and a second round of long-term selections.”
The 1099-Bs investors receive from brokers early in 2012 will have a slightly different look, and the Celent report points out the likely fallout: “…firms are likely to experience an influx of inquiries from clients. Questions may include why some security types are showing [up], but others are not (as a result of later compliance dates for different securities).” In other words: a headache for brokers as they comfort their bewildered customers.
There is a silver lining for brokers that get it right. The ability to help customers manage the tax consequences of a trade can be a terrific benefit. Though some features—such as short-term versus long-term after-tax comparison, tax-lot harvesting, pre-trade tax analysis, and pre-trade wash sale identification and analysis—may not seem to be of critical importance right away, in the long run they are exactly the ones that will keep investors happy.
The free downloadable reportpoints readers to the Scivantage suite, of course. But it also paints an interesting picture of the current reporting conundrum.
The main issue, in our opinion, will be identifying wash sales—the sale of an investment at a loss, followed by the purchase of a similar investment within 30 days—through multiple accounts. The IRS doesn’t care whether you sold a stock at a loss in your Schwab account, then bought the same stock again two weeks later in your E*Trade account. If you do that, you cannot count the loss on the initial sale against your capital gains.
Right now, identifying cross-broker wash sales takes an eagle eye. We’ll bring any automated solutions to your attention.
SCOTTRADE (http://www.scottrade.com) is launching its mobile trading app, and we got a sneak peek at a pre-release iPhone version. (Android and BlackBerry versions should be released simultaneously.)
The app is wrapped in the color I think of as “Scottrade purple”; those familiar with the firm’s Website will be comfortable immediately. Four icons at the top of the screen that let you switch between trading, account data, and research, plus a quick tap to return you to your Home view. The Home page displays market data and has links to real-time news.
You can trade stocks, exchange-traded funds and simple options, and enter some conditional orders as well. There is no complex options trading, though you can set up a one-triggers-another order.
The app brings real-time account and market data to your mobile device, including simple graphs that allow you to change the time frame. Lists of gainers and losers are in the “Markets” section of the Research tab. You can set up a watchlist, and view fundamental data on a stock as well.
There’s no mutual-fund trading in the app, but that’s not a function most investors need on a real-time basis anyway.
Published in Barron’s, July 11, 2011.
