Hello and welcome to my YouTube channel – Trading Software Tutorials.

The first video in this series provided an overview of the three software components necessary for online trading of financial instruments: data, charts and brokers. This tutorial focuses on data: where and how it is generated, what data you need for trading, and the way in which software companies provide data.

But before we do that, we need to make a distinction between, firstly, current data, which is provided by a broker either as static, end-of day figures, or dynamic, real-time data, and, secondly, historical data which may be provided by your broker or by a second party, and which can be used for backtesting entry setups.

Let’s start with current data. To understand where and how trading data is generated, we first need to look at what financial instruments are, and where they are exchanged.

A financial instrument is a contract for a financial security that can be created, sold and purchased, with the contract providing an obligation between the parties involved in the transaction. There are four main types of securities: debt, equity, derivative and hybrid. As retail traders, we are only concerned with equity and derivative securities.  

The difference between equity securities and derivatives is that you own an equity security outright as a monetary asset, whereas you do not own a derivative. Instead, you own a contract that can be traded. The price of an equity security is based on the market sentiment for that particular instrument at any particular moment in time, whereas the price of a derivative security is largely dictated by the price of its underlying equity security or, in some cases, a basket of equity securities. Equity securities are usually traded through an exchange whereas derivatives can be traded either through an exchange or in over-the-counter transactions. However, you need a broker for both types of trades.

For retail traders, the most commonly exchanged financial instruments are:

• equity securities of stocks and exchange traded funds (ETFs)
• derivatives of stocks in the form of options
• spot, futures and CFD contracts as derivative instruments for commodities, currencies, cryptocurrencies and indexes.

Tutorial 5 in this series provides more detailed information about the various financial instruments, and where and how they are traded.

Trade in these various financial instruments occurs on different exchanges according to the type of instrument:

• company securities, that is, shares and options, are traded on stock exchanges
• futures contracts for commodities are traded on futures exchanges
• derivatives are traded on regulated exchanges
• currencies are traded through a global network of banks spread across four major trading centres in different time zones: London, New York, Sydney and Tokyo
• and, finally, cryptocurrencies are traded on specialist crypto exchanges.

There are hundreds of exchanges around the world, with 60 major stock exchanges, 16 of which have a market capitalisation of over one trillion US dollars.

However, it’s important to remember that there may be more than one exchange in each country for a particular type of security, and that including trade data from small exchanges is just as important as it is from large exchanges. For example, in Australia, the major exchange is the Australian Securities Exchange. The ASX had a market monopoly from when it was first established in 1987 until 2011 when the Australian arm of the Chicago Board Options Exchange, CBOE Australia, was accepted as a competitor exchange. This new exchange was initially called Chi-X, then later rebranded as CXA. While CXA currently only trades about 20% of Australian stock transactions, if your broker doesn’t take those trades into account, you won’t get the full picture of price and, especially, volume in Australian stocks traded each day. 

Each security’s exchange produces its own buy and sell data, plus volume data, for each financial instrument that is listed on that exchange. This is the raw data that comprises both the price point and the transfer volume for each individual trade at any particular time.

If your broker only provides end of day data, all you will get is the total volume of shares exchanged for that day and the closing price. However, if your broker provides intra-day data, you will be able to access opening and closing price, and volume data, for each timeframe provided.

Private individuals who trade are called retail traders. That’s you and me. We do not interact directly with the various exchanges but work through a broker which has access to exchange operations and offers our buy and sell orders to the exchange on our behalf.

In theory, brokers have access to the full range of thousands of financial instruments offered around the world. However, in practice, they usually only provide access to a select range. For example, one broker may only offer access to stocks in their own country, while another broker may also offer stocks from a number of other countries, stock options, exchange-traded funds, and futures contracts. While a third broker may additionally offer access to foreign exchange, commodity futures, and cryptocurrency.

However, in your enthusiasm to trade, please don’t fall into the trap of thinking you will choose a broker just because it offers the broadest range of financial instruments to trade. There are many other considerations to take into account when choosing a broker, the detail of which is covered in Tutorial 4.

In addition, in order to fully understand the data that is generated when securities are traded, you need to understand exactly what financial entity is traded in each instrument and any volume requirements for that entity.

For example, for company stocks, shares are traded. Some brokers will allow you to buy a single share, while others may require you to buy a minimum number or trade a minimum value for any particular parcel.

For example, the Australian broker CommSec has a minimum value of $500 for your initial purchase of shares in a particular stock. This is known as a ‘minimum marketable parcel of shares’. CommSec will then allow you to purchase smaller amounts of shares to top up existing shareholdings. This means that if the shares are valued at $1 you must buy at least 500. While this might seem like a good idea to minimise your risk by only buying a few shares, you need to remember that most brokers will charge a set minimum brokerage, so the ratio of brokerage to profit will be uneconomic if you only trade a few shares that are low in individual value. For example, the brokerage for Australian shares charged by CommSec is a minimum of $10. 

Tutorial 5 in this series provides more detailed information about exactly what entity is being traded for the various financial instruments, contract size requirements, and the cost and volume implications of each.

Now let’s come back to the data itself, focusing first on current data. This is the data you need to actually make a trade.

There are three components to raw trading data provided by exchanges.

The first component is the number of potential sellers and the number of potential buyers of a particular instrument. These may be listed as the ‘Ask’ and the ‘Bid’ prices. Just like in an auction, the ‘Ask’ price is what the seller wants from the sale, and the ‘Bid’ is the amount the buyer is willing to pay for that transaction. When they match, a trade is made.

For stocks, this data is often provided as the number of buyers at a certain price, and the total volume for that price, matched against total number of sellers willing to sell at a certain price, and the total volume for that price.

In this example of Australia’s largest mining company, Rio Tinto Limited, there are 5 buyers willing to pay $117.31 per share for a total volume of 260 shares, and there are 5 sellers willing to sell at $117.32 for a total volume of 59 shares, and so on.

Buy and sell data may also be listed by your broker in terms of individual orders. This example is of an order I lodged with my online broker prior to the day’s market open, to buy 10,000 shares of a particular stock at the price of $1.40. After the order was listed, I could then find where it is in the order queue. This order wasn’t filled at open because the stock opened two cents higher, and later in the day it was a long way down in the queue because the price had moved up, well above my bid.

Pre-exchange buy and sell data is important to traders, particularly intra-day traders and scalpers, because the two stacks of potential buyers and sellers provides some insight into which way sales might move. For example, if there are a lot of buyers and few sellers, the likely pressure will be for the price to go up, as you can see from the first example of my buy order where there were 188 buyers for 1.98 million units and 129 sellers for 1.43 million units.  Equally, if the opposite occurs and there are many more sellers than buyers, the likely pressure will be for the price to go down.

In addition, if you want to buy a certain number of shares at a particular price, you might find that either no one is offering a sale anywhere near the price you want, or that there are not enough shares being offered at that price. This is where the stack of ask and bid orders can be very helpful. However, it can also be very deceptive as people who want to manipulate the market will put in false orders, only to pull them out later. This type of game playing is very obvious if you watch the predicted opening price of a stock as it changes up and down just before the market opens.

The second component of current data is the actual trades that are made by individuals or corporations in discrete lots, such as parcels of shares, or number of contracts for foreign exchange. For stocks, these trades will be listed as the course of sales by your broker for each particular company. Again looking at Rio Tinto as an example, the course of sales shows the time of each trade, the price and volume of each parcel, and its total value, the exchange that it traded through (either the ASX or CBOE) and the condition, which means the type of trade. If there is no condition listed it was a normal market transfer. If the code includes the letters XT, which stand for cross-trade, the exchange occurred within the same broker. The codes NX and CX are specific types of cross trades.

The third component of raw trading data is the volume transacted for each parcel. For stocks, this may be as little as one share or as large as millions of shares. As with ask and bid orders, your broker will present a running list of every trade that occurred while the exchange was open, and in any after-market settlements.

Volume data can be tallied in two different ways: as a total for a time period, for example, daily, as shown in the chart on the left, or as a total for a particular price point or bracket of price points, as shown in the chart on the right. The total for the time period is put on the x-axis at the bottom of the chart to match the time points, whereas the total for the each price point is put on the y-axis to match each price point or bracket of price points.

Volume data is vitally important and is used in a range of different ways to assist traders make decisions about whether to buy or sell a particular financial instrument. For example, there must be sufficient volume of any particular instrument for people to trade effectively. This is especially important for intraday traders where rapid exchanges depend on a large volume of stock being available at any particular time. A thinly traded stock will show gaps across the trading day in a five-minute chart, such as this one on the right for Widgie Nickel Limited, indicating that there were no trades at all for most of the day. In contrast, the five-minute chart for a heavily traded stock such as Mineral Resources Limited, shown on the left, shows that there was plenty of volume all day.

Volume data is also important for traders who focus on trading low capitalisation stocks, that is, stocks worth only a few cents, or part of a cent. There is no point deciding to buy ten million shares in a stock that is trading at point one of a cent, if the stock is traded so infrequently that it is impossible to sell them when you want to, even if it is to get out by taking a loss.

Another point to note is that fluctuations in trade volume can provide short-term traders with clues as to what other traders are thinking. For example, a situation where the price of a stock is increasing rapidly but the volume is decreasing, might be a warning that buying interest is waning.

For foreign exchange, the volume traded is usually so large as to be relatively inconsequential for people who trade on a daily timeframe, with the exception of significant national and global public holidays when the volume traded in most financial instruments will drop considerably. For example, while the markets in foreign exchange may be open during the public holiday allocated for New Year’s Day around the world, the volume will be low which increases risk in trading. For traders using a lower timeframe, volume becomes important, especially as it will indicate support and resistance areas.

When the trading day is over, the current data becomes historical. It can then be presented in aggregated form for any particular timeframe, such as a minute, hour, day, week, month or year.

Some brokers only provide end-of-day data in charts for just the closing price, plus the daily volume of transactions. Here is an example from CommSec for National Australia Bank. To get the open, high, low and closing price for each day you would have to look at each individual stock listing, though this is not provided in chart form. 

This is obviously better than no data when you are first starting out, but to get a more comprehensive picture you really need to have the capacity to look at the transaction data in terms of the open, high, low and closing price for each day, and at other timeframes, especially if you plan to be an active trader.

However, while end-of-day data is usually provided free by the major brokers, detailed data that can be viewed in a range of timeframes invariably comes at a cost, such as a monthly fee, although most brokers will offer a discount on access to data if you are an active trader. For example, IG Markets charges AU$20 a month for exchange fees and AU$40 monthly for chart fees, but if you carry out more than a specified number of trades each month, the chart fees are not charged.

Most trading platforms will provide historical data for at least a decade and usually more, often back to the time the particular financial instrument or index was created.

Historical data becomes especially valuable for traders who want to analyse the probability of success of various trade entry and exit systems. This is called backtesting and to do this accurately, high-quality data is needed. 

There is thus another category of trading software company that purchases data from financial exchanges and ensures that it is appropriate for backtesting purposes. To do this, they apply quality controls to the data before offering it to the retail market to be used in third-party backtesting software systems. Such quality controls particularly includes eliminating survivorship bias in price data. Survivorship bias is the tendency to consider only existing or surviving stocks when measuring the performance of a portfolio. Stocks that have ceased to exist are not included, and therefore the probability estimate of success could be overestimated, leading to unrealistically optimistic conclusions.

Backtesting data is available for select financial instruments, such as stocks from American, Canadian and Australian stock exchanges and world futures and foreign exchange rates, but comes only on a subscription basis. The major player in this space is Norgate. However, while Norgate provides the data, it must be fed into specialist backtesting software, such as AmiBroker or System Trader.

Finally, there is one other aspect of data that I need to mention and that is all the information you generate as a trader. At a minimum, you will need to record what financial instrument you traded, the date and, if you are a day trader, the time of the open and close of each trade, the size of the parcel or number of contracts you traded, what your entry setup was, and whether you made a profit or loss. You can of course use a spreadsheet in Microsoft’s Excel or Apple’s Numbers, but there are more sophisticated software packages that help you track your trades in a way that you can see overall trends and help improve your performance.

So, out of all this information, how do you decide what data you need?

Well that depends on what level of trading you are planning to do and what instruments you are planning to trade.

Most people who are on the investing end of the trading spectrum start with stocks. For that, you will need buy and sell data and end-of-day data. This is the sort of thing that local brokers will provide for free when you open an account. If you have never done any trading, this is where you should start. More detailed information about brokers is covered in Tutorial 4 so that you can make your decision as to what broker you will use.

If you have already traded some stocks and are familiar with the concept of trading financial instruments and want to investigate currency or commodity trading, you will need real-time data that is fed to live charts. For this you will not only need access to a trading platform that provides minute-by-minute data, but also provides the capacity to buy and sell directly from the chart. Trading from charts is covered in more detail in Tutorial 3.

And, finally, when you get to the point of wanting to backtest potential trade set-ups, you will need high quality data especially prepared for that purpose.

In this overview, we’ve had a more detailed look at the first of the three categories of trading software: data, charts and brokers. The next video in this series is a more detailed overview of how trading data are presented in charts, and look at a range of charting packages. You’ll find a link to that video in the description below. 

Please let me know if you are aware of a trading software package that lacks good educational resources. I am always open to creating video tutorials in areas of need. 

DISCLAIMER

This video is made available for educational purposes only. It does not provide financial advice of any sort to any person. The narrator of this video is not a qualified financial advisor. Any opinions expressed during this tutorial are the personal views of the narrator and you should not take anything that is said on this video to be advice regarding any investment in any financial product. Should you wish to invest in any financial market, you should seek professional advice from a qualified financial advisor or broker.