You would have to agree that any wise investor will do as
Back testing is the process of testing a trading strategy over historical data to determine how well it would have performed over that set of data. Interpreting these results then provides the trader with sufficient information to assess the potential of the trading system.
Logically, we know that the results from this type testing will not be able to predict future returns. However, it can provide an indicator as to whether you should even pursue a trading system or not.
The truth of the matter is that whatever technical analysis criterion you use to trade with - be it moving averages, candle sticks, volatility breakouts, fibonacci retracements or any other trading system - you're going to need to back test it thoroughly, in order to remove any possible doubt about it's capability.
Without back testing a lack of confidence arises and usually forces traders to question their own trading systems. They give into the temptation to modify their trading plan with devastating consequences. This temptation spawns from a string of losing trades or an opportunity to replace their trading system with a whiz-bang indicator that is usually talked about in trader chat forums.
Anything that sounds to good to be true will attract the attention of any trader who is not satisfied with their trading system, simply because they have not properly tested their system in the first place. In addition, they have not built up the necessary confidence needed to successfully trade the system developed.
In the end, negative subconscious thoughts will only hinder and destroy your ability to trade successfully. To improve your confidence in your trading system, you need to thoroughly and objectively back test it - simple as that! Only then will you be confident enough to commit time and money to it!
The Importance of Back Testing
When trading, what is the question in the mind of the most traders? To answer this question I shall quote the introduction from Chapter 8 “Back Testing” of Mark Jurik’s book "Computerized Trading".
- Will my trading strategy be profitable? After having gone through the arduous process of crafting a trading strategy, this is the question you must ask yourself. The ability to answer that question is the great promise that back testing holds out for all traders. A successful back testing procedure will greatly reduce the probability that you will begin trading with either an unprofitable strategy or one that does not meet your expectations. By adopting a sound and rigorous back testing approach, you will:
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| Pinpoint which approaches to the market that are likely to be successful and which ones are not. |
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| Generate good estimates of future performance for each trading strategy you test. |
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| Create a record of your trading strategy's historical trading performance. |
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| Produce data necessary for other components of your trading approach such as your asset allocation strategy. |
... But the question remains, how can you test a trading system's performance over time? There are only two ways to do this, manually or with computer software. To be honest, computer software is the only “real” option. I have done both testing methods and manual testing is not only time consuming but very hard to replicate and test effectively.
The benefits obtained from back testing software cannot be underestimated. It will save you time and provide an endless opportunity to fine tune and test variations of your ideas. A small outlay in capital to purchase good back testing software will potentially save you thousands, in the market; it is a very wise investment if you are considering designing a successful and mechanical trading system.
For those of you who decided to purchase MetaStock you choice is easy… I have done the research and found the first realistic, true trading simulator/analyzer for Metastock that can quickly back-test and evaluate a trading system across a portfolio of securities. It’s called Tradesim.
In short, TradeSim can evaluate the historic performance of a given trading system within a matter of minutes and do it with a realistic representation of a real-life trading scenario. Whether a single security or a multiple security portfolio, TradeSim answers the simple question:
"What would of happened if this system had of been traded in the past?"
Sounds simple - but it is extremely complex, if not impossible, to do with most charting packages as it stands. However, with TradeSim it is just a simple matter of running it alongside Metastock and analyzing the resulting trade data.
Don’t take my word for it though… here’s what one trader said:
| "I have read dozens of books on trading, subscribed to various newsletters and attended countless seminars, so I thought I knew it all. That was until I purchased Tradesim Professional and boy was I in for a real shock. Believe me when I say this, TradeSim is the best teacher by a long mile..." |
With TradeSim, Metastock becomes more powerful than it ever was - even rivaling trading packages costing many thousands of dollars!
You are probably not aware that to approach the functionality and power that TradeSim adds to Metastock, you would need to spend many thousands of dollars to get the combination of both packages put together. Even then, competing packages fall quite short when it comes to analysis power and options, as well as simplicity of operation. TradeSim was built right from the ground up with the professional trader in mind!
Your system may look good…"But what about its real world trading performance?"
Typically your system will consist of entry and exit triggers as well excellent money management rules. These parameters basically define a framework for a trading system. The trouble with trying to back test a trading system with most other packages is that they provide an extremely limited interface. As a result, with these other packages, you’re given a distorted view of your potential trading system’s performance.
TradeSim addresses all of the above issues, whilst exploring new ground in technical analysis it also uncovers new issues that have not been addressed by current software technologies.
For the first time you can back test your trading system the way you would trade it and objectively analyze its performance! This really is the final step in designing a trading system yet very few traders have the knowledge or patience necessary to test the profitability of a trading system.
I believe back testing is the only way to remove self doubt. Once you have established that you have a reliable and robust trading system only then will you be confident in trading it.
Your next step is to buy yourself a backtesting package - I recommend TradeSim. When you’re ready, in the space below, write down which backtesting software you plan to use:
The final piece in the system design jigsaw puzzle is to take the trading system you have designed in the pervious chapters and test it. By testing your system s you have just put yourself into the top 1% of traders. Congratulations!! You are there!
Let’s get your psychology right.
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