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11-IB19-1167CH1165
Stocks & Commodities V13 (505-509): Computer-Assisted Trading by Tushar S. Chande, Ph.D.

TRADING TECHNIQUES

Computer-Assisted Trading

You can't be a good trader without being a good analyst. But the two are not
synonymous: Just because you're a good analyst doesn't guarantee you'll be a
good trader. To the accomplished analyst, trading is a mental game 80% of the
time, but one for which he or she is poorly prepared. Here's how you can hasten
the transition from analyst to trader.

by Tushar S. Chande, Ph.D.

Copyright (c) Technical Analysis Inc.


Stocks & Commodities V13 (505-509): Computer-Assisted Trading by Tushar S. Chande, Ph.D.

T rading is analysis in action. You have to convert all of your analysis into a simple, executable decision - buy so
much of this, or sell some of that. Analysis is reactive, since you analyze price action after the event. Trading, on the
other hand, is proactive, since you may have to anticipate market events. In any case, trading requires decision
making in the face of uncertainty, with the added knowledge that some of the consequences may be unpleasant. This
is not a simple task, because the fear of unpleasant consequences can trigger various degrees of the "fight-or-flight"
survival instinct, biasing traders' actions.

Besides, the market provides random gratification: The same actions can be profitable or not, with outcomes
occurring randomly. This leads to unprofitable trading habits. For example, you may deviate from your system, only
to be rewarded by the market. When this happens, it only reinforces your tendency to second-guess the model and
deviate from it. Deviating from your model is not bad in itself, but it does negate all the historical testing you may
have done. Since you cannot test your system deviations on historical data, in essence, you end up trading an
untested system.

As a result, trading requires a whole new set of skills, different from those required to be a good analyst. Since there
is no good way to practice these skills before one starts trading, many a venture into trading ends in disaster.

A MILITARY ANALOGY
As a group, the military has faced the problem of decision making in the face of uncertainty with potentially
unpleasant consequences for hundreds of years. What they found was that when push comes to shove, under intense
stress, you can only act on what you deeply believe. Thus, military training, whether it is at the boot-camp or
advanced level, is aimed at giving recruits a new set of beliefs. These beliefs are then coupled to more tangible
activities: a specific strategy, detailed planning, solid training and countless drills or repetitions of the basic tasks.

For traders, their lessons are simple. Every trader needs a strategy, and then he or she must convert it to a specific
plan to produce executable decisions that he firmly believes in. In addition, traders need many repetitions to deeply
internalize the trading process, so they can trade with confidence. For the typical trader, both are problem areas:
weak strategy, and insufficient trading to firmly believe in any trading plan.

For example, in a recent STOCKS & COMMODITIES interview, trader Robert Krausz found that 90% of the traders
he interviewed cited most often the following four problem areas: lack of confidence, no trading plan, inability to
execute and fear of loss.

Krausz concluded that not having a back-tested trading plan was the cause of these problems much of the time. He
went on to comment that in the case of traders who had not back-tested enough, it was quite likely that their
subconscious mind was not completely at ease with the strategy, and stress and conflict were the result. Again, when
traders do not have deeply held beliefs about the trading program, they implement it in an unsystematic way under
the stress of trading. Once they start deviating from their systems, they may be on the way to abandoning those
systems entirely.

Although software packages are available to back-test virtually any trading strategy, no package addresses the mental
aspects of the problem - namely, how to solidify one's beliefs and how to monitor one's trading to correct mistakes
and improve strategies.

COMPUTER-ASSISTED TRADING
I would recommend building a database of your entire trading process. You must separate analysis and trading. In
effect, trading begins after analysis ends. Trading is a sequence of placing an order to take on a position with a
possibly known risk of loss for a possibly quantifiable gain with an uncertain probability of success. The database
records a multitude of details of how you made the trading decision in an atmosphere of uncertainty, given a certain
background of information. The premise of the endeavor is that one can recreate the trading process upon reviewing
sufficiently detailed records of a past trade, and this information can then be analyzed with the additional knowledge
of the profit or loss resulting from those decisions.

Within the context of our military analogy, you can use the historical record to develop deeply held beliefs about your
trading as well as gain needed practice that buttress those beliefs. In essence, you can identify profitable or

Copyright (c) Technical Analysis Inc.


Stocks & Commodities V13 (505-509): Computer-Assisted Trading by Tushar S. Chande, Ph.D.

unprofitable trading habits, and therefore become a better trader by eliminating your weaknesses and reinforcing your
strengths.

Computers may be used to assist in the creation and updating of this database by using a spreadsheet or database
software. You should record the results of your analysis plus all other relevant information, such as your mood,
your analysis of related markets, your account equity, number of winning trades, number of losing trades and so on.
As you review your own trading process, you can add variables that detail how you trade.

After doing so, you can search this database to observe patterns in your own trading, either during simulated or
real-time trading. Another approach is to use technical analysis software to back-test a trading system. Then you can
relive each trade, day by day, and create a database as though you were actually trading the system. This has the twin
benefits of giving you repetitions to work on while reinforcing your degree of faith in the trading system.

The main purpose of computer-assisted trading is to build strong beliefs in the model you wish to trade, and to keep
a detailed record of how you actually trade it. The effect of this training is to reinforce beliefs and good trading
habits, and to identify and eliminate weaknesses. In effect, you can discover the meaning of the oft-repeated dictum
of all successful traders - "Discipline, discipline, discipline." By implementing these suggestions rigorously, you can
hasten your transition from analyst to trader.

A SIMPLE DATABASE
I used Microsoft Access to create a simple database application to help me in my trading. I will not discuss the many
database design issues that come up but have provided some references you can use. A well-designed database
avoids redundancy and allows complex searches of information within the database.

In one simple layout, shown in Figure 1, I've captured three essential elements. First, I have space to enter a specific
trade plan. Implementing this step alone may cure most of your problems. Second, I have room to enter the
probability of winning, the dollar amount to be risked and the dollar amount of profit target. Then I use this
information to calculate the expected return or average trade dollars. That is my statistical edge: If all my trades were
made with these sets of data, I would, on average, earn $438 per trade, or after 100 trades, reap $43,800 in profits.
Third, I have defined an action group to measure how well I am following the plan. For this hypothetical trade, I am
willing to enter into the trade. I am trying to measure if I have a tendency to get in late (delay entry), get out too soon
(exit now), or get out too late (delay exit). Broadly speaking, I want to log if I am sticking to my plan or want to
modify it to meet my comfort level.

Copyright (c) Technical Analysis Inc.


Stocks & Commodities V13 (505-509): Computer-Assisted Trading by Tushar S. Chande, Ph.D.

FIGURE 1: ONE LAYOUT, THREE ESSENTIAL ELEMENTS. In one simple layout, Chande has
captured three essential elements. First, space to enter a specific trade plan. Second, room to enter the probability of
winning, the dollar amount to be risked and the dollar amount of profit target. Third, an action group to measure
how well he is following the plan. With these elements, the trader is able to keep a running log of how he or she is
trading.

STEADY MAINTENANCE
It is essential that I maintain this database every day. For example, on the Monday after the entry shown in Figure 1,
I might be willing to adhere to the strategy (Figure 2). Eight days later, however, the market may have gone
sideways or risen far above my expectations, and I may want to deviate from the strategy (Figure 3). Say I choose to
exit the trade because I feel the market has gone up too far too fast or the market is locked in a trading range. I will
have to monitor this trade until my exit criteria are met, for the market can continue going up even more strongly or
begin to trend strongly - in either case, I got out too soon. As I record my trading process over many months, some
clear patterns may emerge, such as a tendency to get out too soon. I can then work to consciously alter this pattern by
setting up other specific criteria.

Copyright (c) Technical Analysis Inc.


Stocks & Commodities V13 (505-509): Computer-Assisted Trading by Tushar S. Chande, Ph.D.

FIGURE 2: DATABASE MAINTENANCE. This database should be kept up every day. For example, on the
Monday following the entry in Figure 1, the trader might be willing to stick to the plan. But …

Copyright (c) Technical Analysis Inc.


Stocks & Commodities V13 (505-509): Computer-Assisted Trading by Tushar S. Chande, Ph.D.

FIGURE 3: PLANS CHANGE. But eight days later, the market may have gone sideways or risen far above
expectations, and the trader may want to deviate from the plan.

Computer-aided trading differs from keeping a simple diary because I can perform complex searches that would be
difficult with a text-oriented diary. Further, using a database, I can keep track of equity or risk control parameters
automatically, which would be next to impossible in an ordinary diary. As another example, I can copy over
yesterday's diary as the starting point for today's entries, only changing the ones I need. This, too, would be
impossible with a conventional diary.

In another variation, suppose I wanted to keep track of my trailing stop (Figure 4). Say I had done my testing with a
trailing stop of $2,500. However, because I have had four losing trades recently, I wanted to tighten my stop to a
point on the chart below a recent consolidation, even though it is only $1,345 away. This may seem like a minor
deviation, but in testing, you would find significant differences in model performance. Thus, I have created a major
deviation from my strategy. Further, I can find another item to reinforce my trading beliefs. For example, I can redo
my test results for a stop of $1,350 and compare the results to those with a $2,500 stop, and revisit all the trades.
This might convince me that I should revert to my $2,500 stop.

Copyright (c) Technical Analysis Inc.


Stocks & Commodities V13 (505-509): Computer-Assisted Trading by Tushar S. Chande, Ph.D.

FIGURE 4: KEEPING TRACK OF TRAILING STOPS. In another variation, say the trader wanted to
keep track of a trailing stop. Say he had done his testing with a trailing stop of $2,500. However, because of
circumstances, you may find that you feel you must deviate from your strategy. By logging this fact, you can find
another item to reinforce trading beliefs.

In Figure 4, I have shown how easy it is to add two more elements to the database seen in Figures 1 through 3. I
added a button selector to log if I have entered the order for a particular new trade. I also added a box to enter the
dollar amount of my trailing stop. In my own trading, I have observed that I am often reluctant to enter an order. I
know from experience that if I have not entered an order with my broker, I will not put on the trade. I have also
noticed that subsequent market action often proved me right. Now I can actually log this information and then do a
search to find out how often. I like to be a system trader but seem to have a well-developed sense for market action.
With enough data, I can support my instinct with hard numbers, and would perhaps then be comfortable trading it as
yet another system.

DATABASE APPLICATION
With enough thought and planning, you could build a sophisticated database application that you can use for
computer-assisted trading. You can also use a spreadsheet; though this may not be the most elegant design, you
could start to log some information. As markets and trades increase in number, the importance of a good database
design quickly becomes apparent.

One of the advantages of using a spreadsheet is you can quantify any trading-related variable on a numerical scale. In
Figure 5, I show a small spreadsheet where I have illustrated using text fields and numerical fields. The "Following
Plan" field has its entries as "yes" or "no." However, I have quantified the other fields on a scale of zero to nine,
such as the urge to exit, resistance to entry, stop control, fear factor and comfort level.

Copyright (c) Technical Analysis Inc.


Stocks & Commodities V13 (505-509): Computer-Assisted Trading by Tushar S. Chande, Ph.D.

FIGURE 5: QUANTIFYING VARIABLES ON A NUMERICAL SCALE. An advantage of using a


spreadsheet is being able to quantify any trading-related variable on a numerical scale. Here's a small spreadsheet with
text fields and numerical fields.

For example, I was comfortable with a short trade in the Swiss franc in early February. I was not following any
specific plan, and my urge to exit the position was quite strong. So I did. This was a discretionary trade, and hence I
felt I was not following a plan. As I recognized the uptrend and took a long position, I was trading in my comfort
zone in a trade I was happy to have. As the market got stronger, I bought more, but I was hesitant to add the extra
position and was a little concerned I might get stopped out. In retrospect, there seems to be some contradiction: I was
comfortable with this trade and yet recorded a fear factor of seven. Clearly, this was an area I needed to clarify to
myself. As the Swiss franc rose strongly and volatility increased, I became uncomfortable with the position and
exited, even though that meant deviating from my original plan.

Later, I could search the spreadsheet in Figure 5 to find out how often I had contradictions (high values for fear
factor and comfort level at the same time) or deviations from my plan. As you track your trading, you may find
patterns that point to areas of strength or weakness. The built-in data sorting routines in a spreadsheet are very useful
for doing analysis of this sort. Also, I could copy over an entire row and only change the fields I want. This could
reduce the amount of work needed to maintain the database.

As the number of records in my database increase, the spreadsheet becomes clumsier to use, and it becomes more
difficult to summarize my previous entries efficiently. This is where a database-oriented approach pays dividends. In
either case, you may be better off going with a professionally designed product to save time and effort while gaining
efficiency and convenience.

RELIVING HISTORY
As a trader, it's tough to get enough practice before risking real capital. As any starting quarterback can tell you, you
never seem to get enough practice before a game. One way around this is to use computer-assisted trading. You can
set up a system test using any available technical analysis software. Then you can scroll through each day of the test,
one at a time, and fill in your impressions in a database (Figure 6).

Copyright (c) Technical Analysis Inc.


Stocks & Commodities V13 (505-509): Computer-Assisted Trading by Tushar S. Chande, Ph.D.

FIGURE 6: COMPUTER-ASSISTED TRADING. You can set up a system test using any available
technical analysis software. Then you can scroll through each day of the test, one at a time, and fill in your
impressions in a database as shown here. With both a technical analysis package and the database package, you can
go back and forth, recording your impressions. You can observe some pattern that may help you predict if a
particular model trade is going to be profitable.

I have a technical analysis package and the database package running simultaneously in Figure 6. I can go back and
forth between the analysis and the database, recording my impressions. For example, you can observe some pattern
that may help you predict if a particular model trade is going to be profitable. You can record this observed pattern in
computer-aided trading and search this database for supporting evidence. An important benefit of this exercise is that
you can form a belief system that reinforces your confidence in a particular model, hence solidifying your ability to
actually trade it.

UNEQUAL AND COINCIDENT REACTIONS


Trading can have its ups and downs. You may have a streak of winning trades that might make you euphoric.
Conversely, a string of losing trades may depress you. In the market and the external world, the effect of your
trading is equal and opposite, since there must be another trader to take the opposite position. However, in your
internal world, in your psyche, a given trade may produce a disproportionate reaction neither equal nor opposite its
market effect. Your magnified internal response to losses and gains in the external market can exaggerate the impact
of market events. A large winning trade may not cause you to feel any extra happiness, since you expect that
performance from yourself. However, a somewhat larger loss than usual due to an unfavorable opening gap might
cause you to blame yourself for not reacting quickly.

Logging your thoughts and emotions is one way for you to get the load of the market off your mind, feeling more
relaxed in the process. Months later, you can review your comments and note the market events that cause these huge
emotional reactions. Then in the future, when similar triggering events occur again, you can downplay their

Copyright (c) Technical Analysis Inc.


Stocks & Commodities V13 (505-509): Computer-Assisted Trading by Tushar S. Chande, Ph.D.

importance and reduce their effect on their trading. Thus, this computer-assisted trading can help you steady yourself
emotionally.

VISUALIZATION
A popular technique among athletes is the practice of visualization, in which you mentally rehearse the activity you
are about to perform and prepare yourself to do your best. This form of autosuggestion has worked successfully for
many participants. You can use computer-assisted trading to visualize your trades. The process of writing the trade
plan can be used to imagine the entire trading process, such as entering your order and following the risk control
guidelines you have established. You can reinforce the behaviors that help you trade better. This will help you focus
on your trading and reduce the stress that trading may induce in you.

SEPARATING TRADING AND ANALYSIS


There is one important benefit of using computer-assisted trading, and that is separating the process of analysis from
trading. As a beginner, this means you can get over your fascination with indicators and beguiling charts. As an
expert, this means you can focus on converting your instinct after analysis into tradable decisions. Remember,
money is made by trading, not just analysis.

There are other benefits, among which is you can systematically track the types of stresses you are sensitive to and
what your reaction tends to be. You can then work to correct these tendencies, becoming a better trader in the
process. As with everything associated with trading, you must be persistent and complete the database every day for
it to be really useful. It all goes back to the cardinal rules of trading, the three rules for success: discipline,
discipline, discipline!

Tushar Chande is a Contributing Editor for STOCKS & COMMODITIES.

REFERENCES, RESOURCES, READING


Chande, Tushar [1995]. "The time price oscillator," Technical Analysis of STOCKS & COMMODITIES, Volume
13: September.

Hartle, Thom [1995]. "Trading with the conscious and subconscious minds: New Market Wizard Robert Krausz,"
interview, Technical Analysis of STOCKS & COMMODITIES, Volume 13: September.

Jennings, R. [1994]. Database Developer's Guide with Visual Basic 3 , Sams Publishing.

Knuth, D.E. [1973]. Sorting and Searching , Addison Wesley.

end

end

end

Copyright (c) Technical Analysis Inc.


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