The Time Tested System: Trading Backtesting
The trading backtesting is the process of testing a trading strategy using historical data rather than testing it in real-time with real money.
You have designed your system, now you need the confidence to follow through with all your trades.
Through backtesting, you will come to know your system thoroughly and therefore will be able to build a baseline from which you can act.
There are three ways to backtest.
First, there is mechanical back testing, using software; manual backtesting and paper trading, which is taking the system and trading in real-time without any money being in involved.
With mechanical backtesting, you take your system, define it into a set of rules and load it into your software and allow the software to backtest it over a period of time.
This method may be hard if you are not particularly computer literate in programming in a system for backtesting.
Also, you can't program in all possible outside events.
For instance, how could you possibly program in the events of September 11? It is not going to be possible to take into account all outside events.
Manual backtesting is a better option if you are finding the software difficult and is easier to implement.
However, there is in manual backtesting room for human error and subjectivity, which you don't find with mechanical backtesting.
Paper trading, where you trade in real time without using any money, has the advantages and disadvantages of manual backtesting.
The trading backtesting affects first, your entries and exits.
You can test your entire system's performance and can make any necessary adjustments needed.
It will affect money management.
You can test various money management systems using backtesting.
Finally, psychology is affected by backtesting.
A thorough understanding of your system's strengths and weaknesses will greatly improve your trading confidence.
Without testing, traders will lack confidence and will give into the temptation to modify their trading plan and replace their system with any new whizz-bang indicator that comes along.
Once your trading system has been backtested, though, you will be able to continue trading even after a long string of losses, if historically you have seen that you can still come out ahead after making that number of losses.
Many charting packages have backtesting built-in.
If it doesn't have this facility built-in, you need to find one that is compatible with a backtesting package.
This is the only way to remove self-doubt.
However, do not test and retest in the hope of stumbling upon that magic bullet.
Realize that no trading system is ever going to be one hundred percent successful.
What you should be looking for is a good trading system with minimal drawdown and a good risk-to-reward ratio.
Many trading systems have more losing trades than winning ones and yet still make money.
Keep in mind that trading backtesting is a very worthwhile investment of time and money.
It will give you the ability to understand your trading system inside and out and will give you the confidence to trade your system successfully.
You have designed your system, now you need the confidence to follow through with all your trades.
Through backtesting, you will come to know your system thoroughly and therefore will be able to build a baseline from which you can act.
There are three ways to backtest.
First, there is mechanical back testing, using software; manual backtesting and paper trading, which is taking the system and trading in real-time without any money being in involved.
With mechanical backtesting, you take your system, define it into a set of rules and load it into your software and allow the software to backtest it over a period of time.
This method may be hard if you are not particularly computer literate in programming in a system for backtesting.
Also, you can't program in all possible outside events.
For instance, how could you possibly program in the events of September 11? It is not going to be possible to take into account all outside events.
Manual backtesting is a better option if you are finding the software difficult and is easier to implement.
However, there is in manual backtesting room for human error and subjectivity, which you don't find with mechanical backtesting.
Paper trading, where you trade in real time without using any money, has the advantages and disadvantages of manual backtesting.
The trading backtesting affects first, your entries and exits.
You can test your entire system's performance and can make any necessary adjustments needed.
It will affect money management.
You can test various money management systems using backtesting.
Finally, psychology is affected by backtesting.
A thorough understanding of your system's strengths and weaknesses will greatly improve your trading confidence.
Without testing, traders will lack confidence and will give into the temptation to modify their trading plan and replace their system with any new whizz-bang indicator that comes along.
Once your trading system has been backtested, though, you will be able to continue trading even after a long string of losses, if historically you have seen that you can still come out ahead after making that number of losses.
Many charting packages have backtesting built-in.
If it doesn't have this facility built-in, you need to find one that is compatible with a backtesting package.
This is the only way to remove self-doubt.
However, do not test and retest in the hope of stumbling upon that magic bullet.
Realize that no trading system is ever going to be one hundred percent successful.
What you should be looking for is a good trading system with minimal drawdown and a good risk-to-reward ratio.
Many trading systems have more losing trades than winning ones and yet still make money.
Keep in mind that trading backtesting is a very worthwhile investment of time and money.
It will give you the ability to understand your trading system inside and out and will give you the confidence to trade your system successfully.