An important element in market analysis and in the development of and testing for trading systems is understanding the information you are using. Technical analysis and trading systems are dependent upon that data that they employ. If you don’t know what you are putting in to your work, you cannot be sure of the validity of the output.
There are two primary ways you will see and/or receive price quotes. One will be in the form of traded quotes. That means actual prices at which transactions took place. Generally, this is what you will get in the stock market and in futures. The quotes for exchange-based instruments usually are traded price. This is very straightforward and easy to understand.
If you are trading a non-exchange market such as spot forex, though, there is no central transaction mechanism, thus no single pricing source. The quotes that are provided are indicative ones, specifically the bid and ask/offer prices in the market. These are not prices where trades necessarily took place, but rather where they could have done.
Knowing which you are getting in your data is important. In the case of the traded prices, sometimes they are not a good representation of where you could actually buy or sell. In a very active market, traded price will be very close to the current bid-offer (there is always an active bid-offer in every market). In a less active instrument, though, the last traded price may not be reflective of where you can actually buy or sell because it was some time in the past. Take a look at the options market sometime to see examples of that.
If your data feed is indicative prices then you will want to know two things. First, which price is the feed based on. Most use the bid price, though some use the mid point between the bid and the offer. Second, you need to know the spread. You will be buying at the offer and selling at the bid when you do transactions. That’s a kind of built in transaction cost that must be accounted for in your profitability analysis. If you don’t have this information, you will not do the best job you can in accurately assessing entry and exit points for your trades. This can make a HUGE difference in the results of your trading system or methodology when you do your testing.
So the morale of the story is know what data you are using and what it means in terms of your position entry and exit.
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About the Author
John Forman, author of this blog, has traded for more than 20 years, is a professional market analyst, and authored The Essentials of Trading. He is an active participant in trading forums, consults for trading related businesses, as published literally dozens of trading articles, and has been quoted in a number of books and in the media.
** See John’s full bio.
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