Backtesting, APIs and other tools to assist you in rule based trading

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So, in the previous chapter of this module, we saw the basics of how you can get started with rule based trading. That said, having all of the required equipment and knowledge exposure may not always be enough for executing rule based trading without a hitch. You would also need the help of certain tools to assist you on the path to becoming a rule based trader. These tools play a key role in not only setting up, but also deployment and evaluation of the trading system. And that’s exactly what we’re going to be looking at in this chapter of Smart Money. Let’s begin.

Tools that you need for rule based trading

As you’ve already seen above, to achieve success through rule based trading, you would need the assistance of a few tools. Here’s a quick overview of 5 of the most important tools that you would need to include in your repertoire.

1. Charting tools

Regular stock trading is not possible without the help of charting tools. This statement holds true for rule based trading as well. You would need to employ a powerful charting tool that’s capable of displaying stock market data on a real-time basis. That’s not all.

The charting tool should be versatile and compatible with rule based trading softwares. It should also be able to display a variety of data such as India VIX data, which essentially indicates volatility. There are several charting tools that you can find online. While some of them are free, others may charge you a small fee for accessing advanced features.

2. Microsoft Excel

Next up on the list of tools that you need is a powerful spreadsheet program like Microsoft Excel. Excel is an excellent program that allows you to organize, filter, analyze, and understand data in a better manner. As a matter of fact, with Microsoft Excel, you can import the data generated by the charting tool for data analysis and manipulation.

Take India VIX or other volatility data, for instance. A charting tool generates a significant amount of data for every trading session. By importing the data onto a spreadsheet program like Excel, you can organize and filter out the noise, which is essentially unwanted data.

That’s not all. Excel also allows you to write algorithms through the macro function, which can later be exported to either backtesting tools or to a rule based trading program for real-time execution.

 

3. Backtesting tools

Now, whether you use Microsoft Excel or any other program for writing trading algorithms, you should always test them out to gauge their performance and efficacy. That said, you can’t simply put them to use in real-time trading scenarios now, can you? If the algorithm doesn’t work as intended, it can cause significantly heavy losses.

This is one of the primary reasons why it is absolutely crucial to do backtesting before deploying your rule based trading programs out in the real world. Now, there are several tools online, both free and paid, that you can use to backtest your algorithms to see just how it performs.

These backtesting tools simulate real-world trading by using historical price action data of stocks and indices. Therefore, you don’t have to worry about incurring any losses if your algorithm doesn’t work as expected.

4. Modeling tools

Backtesting tools generate a lot of data. This data is not always generated in a user-friendly or user-readable manner. When you backtest your rule based trading algorithm, the performance results may at times be presented to you in pages upon pages of numbers. How do you make sense out of it?

Here’s where modeling tools come into the picture. These tools can help translate raw data such as the one generated by backtesting tools into something that’s more user-friendly. To put it simply, the tool represents the number data in a visual format using bar charts, pie charts, and other pictographic representations. This allows you to better analyze the performance of your algorithms.

5. Application Programming Interfaces (APIs)

Now, let’s say that you’ve done extensive backtesting of your trading algorithm and are happy with the results that it produced. You would now like to put it to use by deploying it in real-world market conditions. To do so, you would have to integrate your rule based trading algorithms with your trading platform. But then, how do you go about doing that?

Here’s where an Application Programming Interface (API) can help. APIs are essentially lines of computer code that help two or more software programs interface with each other. Even if the software programs are coded in entirely different programming languages, an API can help them communicate and transfer data with each other.

For instance, say your trading algorithm was coded in Python and your trading platform was coded in Java. You could use an API to link both of these software programs with each other to enable your algorithm to send trading instructions to your platform, which would then execute them.

Wrapping up

That’s about it for this chapter of this module. Here’s a parting note. Remember to always test your rule based trading plan extensively under various market conditions before actually deploying them. Mastering the use of these five tools, especially backtesting, can help you go a long way when it comes to rule based trading.

A quick recap

  • Regular stock trading is not possible without the help of charting tools. This statement holds true for rule based trading as well. 
  • Microsoft Excel is another excellent program that allows you to organize, filter, analyze, and understand data in a better manner. As a matter of fact, with Microsoft Excel, you can import the data generated by the charting tool for data analysis and manipulation. 
  • Backtesting tools simulate real-world trading by using historical price action data of stocks and indices. 
  • Modeling tools help translate raw data such as the one generated by backtesting tools into something that’s more user-friendly. 
  • APIs help two or more software programs interface with each other.

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FAQ'S

Charting tools can help you understand and account for historical price movements while framing the rules for your automated trading strategy. These historical price movements can help predict the future price movements over the short term. Hence, charting tools play an important role in formulating your rule based trading strategy.
Backtesting is the process through which you can test how well your rule based trading strategy would have worked for a given set of historical data or circumstances. It helps you test how good your rule based trading strategy is, so you can find the best trading system to employ for your future trades.
It is generally advisable to have a bit of coding and programming knowledge to make the most of rule based trading. However, these days, many stock broking partners and financial service providers offer smart API tools that are useful for beginners too.
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