Introduction to the ScaleTrader Algo Webinar Notes

Overview

Interactive Brokers' ScaleTrader algorithm can be used to maintain a low profile when buying or selling large volumes of stocks, options, futures, forex. The algo can be used to trade bonds, CFDs, futures options and warrants and is designed to slice large buy orders in to smaller, more manageable amounts, buying at lower prices. Orders to sell are split up according to the investor's choice, and each slice is designed to trade at increasingly higher prices.

A significant feature of the ScaleTrader is that it can be used to trade around a position. In other words, an investor entering a buy order can, at the same time, create profit taking orders on the same order entry screen aiming to sell at a profit, portions of the completed buy order at pre-determined prices.

In today's session we will look at setting up a basic trade using ScaleTrader. Then we will focus on adding profit taking inputs, before also looking at how ScaleTrader may be used to trade a pair of securities.

Locating the ScaleTrader

Remember that ScaleTrader is an order type, which means that you can click-right on any ticker symbol from the main page within Trader Workstation (TWS) to reveal the drop-down trading menu. Follow the root through Trading Tools and select ScaleTrader. Note that if you are looking for this option for the first time, you may need to click on the expand arrow at the bottom of the menu to reveal ScaleTrader.

Alternatively, from the trading menu across the top of TWS, use the drop-down arrow to reveal more icons and from there you can select the ScaleTrader icon. Within Mosaic, using the New Window menu choose from the Advanced Trading Tools menu, the More Advanced root and select ScaleTrader.


Chart - Locating the ScaleTrader

Introduction to the ScaleTrader Algo
Introduction to the ScaleTrader Algo

By selecting this option an order entry screen appears. You should easily notice the chart of the security that occupies the right side of the ticket. This is an integral part of the order entry process, from which you can click and drag your entry prices. Of course those prices can be manually added to the left of the screen. Notice across the top of the chart that a choice of timeframes is listed, which changes the period of price history shown in the chart. Below the chart is a Summary area, which provides an update on the progress of a trade during its execution. Note also that the Summary information will appear when all applicable fields are populated to allow a preview for the number of price levels, the average price should the entire order fill, the total value of the trade in local currency, and the price range for the trade based upon user inputs.


Chart - Basic ScaleTrader input area

Introduction to the ScaleTrader Algo

The ScaleTrader input area displays a price quote at the top of the page, including a position field so you can see what your current or existing position is. Naturally this field will change as the trade goes through the execution process. You should also notice that above the quote panel are three tabs – Simple, Pair and Combo. For single stock entry we need to use the Simple tab. You will also see that two fields must be filled in – maximum position and initial component size. Without these, the order entry will not complete. As we go through populating the fields, notice how other fields become required. Customers should populate other fields at their discretion.

To the left of the ticket there are three areas – the basic Scale Order entry area, Auto price adjustment and Profit Orders. Let's deal with entering a basic ticket starting with Scale Order entry and you will quickly see how the chart and remaining fields populate as we start to enter data.


Chart - Adding some data to Scale Order entry area will populate Summary area

Introduction to the ScaleTrader Algo

Noting the Action button beneath the three tabs, ensure that you select the appropriate purchase or sale field by clicking in the Buy or Sell circle to the left of either button. The first step is to add a maximum position size – the number of shares you want to buy or sell. You must next decide how you want to reduce the overall order into smaller pieces by choosing the size of the first slice of your order. Enter a value for the initial component size for the first slice of you order. You can leave this field blank and only input a value for Subsequent Component Size. This way the order will use this value for both initial and subsequent component sizes for the remainder of the order. Note that you can attempt to further hide your market presence by checking the box titled 'Randomize size by +/-55%'.

Next, you must decide what price you want the algorithm to make its first purchase (for a buy order). Note that you can either drag the starting line within the chart to above or below the prevailing trading price or you can type in a value in the Starting Price input field. You can now perform either process for the bottom price by clicking on the chart or type directly into the Bottom Price field. You may add a value in the price increment field, which regulates the limit price for subsequent component sizes, or by clicking on the chart to determine the bottom price, the increment will self-populate. So for example, for a stock trading at $65.60 per share, an increment of 0.05 or a nickel for a buy order would create a second buy order at $65.55 and a third order to buy at $65.50. And so you should be able to see that our large order is now being shredded into smaller blocks and that the entry price is always dropping as order completion progresses.

The Summary box will confirm the number of trades based upon the desired position and size of subsequent component sizes. For some investors, it will be apparent that you can determine your entry price range by using the chart. Note also that you can chose from three order types in case that's an important factor to you. These are LIMIT, MARKET and RETAIL PRICE IMPROVEMENT for NASDAQ and NYSE-listed stocks participating in that program. For more information, please look under the Order Type page of the IB website.


Profit Taking

While the ScaleTrader algo can be used just to either buy or sell, it can also be used to create profit taking orders. Click the appropriate box in the order entry area and then determine the profit offset. So for an initial purchase filled at the price of $65.60 per share, a profit offset of 0.25 (one-quarter dollar) would create a first sell order at $65.85 while maintaining all subsequent buy orders at the increment used earlier. If the second buy order one-nickel lower at $65.55 is filled, TWS will then create a second sell order at $65.75. If the share price rises through your profit taking price, the order should fill. Essentially you are trading a range at this point attempting to buy and sell within that range. Your buy order will continue to fill under these conditions as the share price falls and offsetting sell orders will accumulate. Note that you have the choice to restore your trading size back to its full amount, in which case all previously used buy and sell levels will be repeated, or else you could elect to use them only once and let the initial trade plan run its course.

From the Activity monitor in Mosaic or from the order entry line in TWS you can click-right and select View Scale Progress when the order is in progress. Note that this is unavailable when the order has been cancelled or completed. This is really useful in terms of showing what stage your order has reached as the share price rises or falls and touches your buy or sell parameters.


Table - ScaleTrader buy order with Profit Taking active

Introduction to the ScaleTrader Algo

Pair Trading

Let's turn to the second tab along the top of the ScaleTrader order entry screen to look at trading a pair of securities. By clicking on the Pair tab you will create a button to the right of the order entry ticket prompting you to Edit Pair. As you do this you will be prompted to enter the BUY side on the top line and then the SELL side beneath it.

Introduction to the ScaleTrader Algo
Introduction to the ScaleTrader Algo

Typically, investors want to buy an equal dollar amount of stock in Company A as they sell in Company B. For this reason there are two ways of considering the trade price or the value of the deal. When complete, hit the Create button to the right. Note that having entered both stock symbols, a pricing method will appear to show Net amount and Price difference.


Net Amount

The Net amount calculates the dollar difference based upon the component size of the trade. This is because TWS values each leg of the order individually and computes the dollar difference. The difference is a function of the component size and NOT the maximum order size. TWS will automatically build a spread of 100 shares per side as its default, but we need to make some adjustments. The first step is to manually compute the Maximum Position from which you can compute the required ratio you want to buy and sell. To do this, divide the required dollar investment amount by the share price of Company A (buy stock) and then figure the same for the number of shares of Company B (sell stock). You may want to round each value as required.

Next populate the buy and sell amounts. You may at the same need to clear the 100-share values populating the Component Size fields.

Next, determine and enter the required component size in the appropriate field. The software might automatically calculate the appropriate number after you enter one side based upon the data entered in the Maximum Position. If you look at the top of the order entry area or the Contract line you should see the ratio of the order you created (for example, +(100) F – (50) GM).

Now enter the Starting Price and Price increment, which will generate the Bottom Price. At this point you may want to vary the Price Increment field as this will determine the number of price levels required to complete the order. You have now established a price range over which the order should execute. Note in the Summary area below the chart you can see the Number of price levels field displayed, which will change if you alter the Price Increment or Starting Price data.

You have now completed the minimum number of data inputs in order to transmit your order, which can be done by clicking the blue Transmit button at the bottom of the order entry area. Note you can Preview, make changes before accepting any changes or you can cancel the order by clicking on the Dismiss button. When the order has been transmitted, Start, Stop and Cancel Order buttons will become active.


Price Difference

ScaleTrader will alternatively display the price quote as the difference between the outright prices of Company A and Company B. This maybe more intuitive for some investors looking for a narrowing or widening in the values of two stocks' prices.

To see this using the same example, click on the Edit Pair button and select Price Difference. Click on Create pair and you should notice that the new price quote is displayed with reference to the price of the BUY stock minus the price of the SELL stock, such that a negative reading is the result of a lower share price for the long leg of the combination. You can still maintain the integrity of the ratio as shown previously and you will need to enter your Maximum positions for Buy and Sell amounts before changing the Component Size. Notice now that your Starting Price is expressed in relation to the difference between the prices of the two underlying share price values.

The quote display method is entirely your choice. The important thing to remember is that you need to compute the desired number of shares for each leg of the trade, which means that you are calculating the ratio. The ratio is not input separately, but governs the values you can enter for the component size. In turn, the component size determines the number of price points and the number of trades you will generate in order to complete the execution. That range is governed in part by the value of the Price Increment you choose.


Chart - ScaleTrader using Price Difference instead of Net Amount

Introduction to the ScaleTrader Algo

Auto Price Adjustment

For investors wanting to maintain discretion over their market impact, ScaleTrader allows you to vary the time each order is released in order to lessen the chance of detection by other traders. Simply click the Auto price adjustment box and enter variables in the size and time input fields. Once again, you can use the Profit Orders area to trade around the position by creating profit taking orders and selecting a value for Profit Offset.

Finally for investors trading Exchange for Physicals (EFPs), futures and options combinations, select the Combo tab for setting up orders.


Display

Completed trades using ScaleTrader will appear, as usual, on your Portfolio tab in TWS. By clicking right on any ticker symbol and selecting ScaleTrader from the Trading Tool menu will allow you to exit (or establish) a position using the algo. Pair trades completed using ScaleTrader are displayed using the ratio used in the Contract description field. Once again, clicking right and selecting the algo will allow you to create an opposing trade out of the open position using ScaleTrader.


Chart - Portfolio page display

Introduction to the ScaleTrader Algo

Summary

ScaleTrader is a highly useful tool for building positions over a trading range at the discretion of the investor without alerting other traders. Investors wanting to "scale" into a position can determine in advance the top and bottom of a trading range in which they wish to establish a position. They could also use specific dollar and cent price changes to enter pieces of the overall position. In addition the ScaleTrader can be used as a vehicle to trade in-and-out as prices move over a range. ScaleTrader can be used to efficiently establish positions between two securities, or futures and options combinations, should an investor develop a view on competing share prices.