This is the fourth in a series of posts about how and why and how I started down the path of automated trading. Here’s the first, second, third, and fourth posts in the series (RSS). Our automated trading robot is available now. Trade your own strategy automatically with no coding required.

Now there’s a word that means a lot of things to different people: backtesting. Ask 5 traders what they think of backtesting and you’ll get at least 5 different responses - from “backtesting is worthless” to “I wouldn’t even consider trading without backtesting first”.

Here’s my take on backtesting - it can be an extremely valuable tool depending on the trading system you use it for. In fact, in some type of systems it’s just not practical to start trading without backtesting first.

You’re At Step One Of…

One thing that a lot of new backtesters overlook is that backtest results are simulated. It doesn’t reflect actual participation in the markets. What often happens is someone develops a strategy that tests really well and then they start trading with it, fall flat, and then they get mad at the backtest. There are a whole variety of reasons that actual trade results don’t match up exactly with backtested results.

The important thing to remember is that when you develop a strategy that backtests well, you’re just at the beginning stages of trading a profitable strategy - there’s a lot more work left to do after this step!

Organize your Backtesting

When you set out to backtest strategies, it can quickly become overwhelming if you don’t have a plan for organizing results. It’s very easy to make adjustments and then lose track of what you changed and where you started - especially if you use the Trade-Ideas Odds Maker, which allows you to test strategies very, very quickly.

StockTickr has a built in “version control system” for trading strategies and backtest results - it allows you to archive, combine, and compare backtest results. You can even share a backtest with others if you choose to. So basically, StockTickr does all the heavy lifting for you automatically.

Compare the Backtest with your Actual Trades

It’s a depressing feeling when you trade a strategy, lose money, and then look at the backtest and it indicates you should have made money. Remember above where I said there’s a lot more work to do? This is where that begins. A lot of traders just abandon the strategy here or just start throwing a tantrum, but understanding why most strategies underperform the backtest is part of the process.

There are a lot of techniques to use to figure out how to get more money out of your automated trading system and comparing your backtest results with your actual results should give you some hints on where to start.

I’ll address these steps in more detail in the next post.

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Joey, the Downtown Trader, was one of the earliest users of the automated trading robot. He’s done it the right way - using demo mode for a good while and started trading live and building size.

It’s great to follow his progress on his blog - yesterday he had his best day ever with 21R. Nice!

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The good doctor Brett Steenbarger gave an excellent talk at the Forex Trading Expo and they put up the video of it which you can see in it’s entirety. It’s a great presentation that is well worth 45 minutes or so of your time. He mentions StockTickr in it, but that’s not the only reason it’s good.

One thing he mentions that hit home was to focus on getting the most out of your strengths instead of trying to improve your weaknesses.

Check it out if you can.

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I came across this article by Alan Farley (who I interviewed a while back). In the article he describes his trading desk and how he has things arranged, what subscriptions he has, etc. I’m always interested in hearing how other traders’ have things arranged - I devote a good deal of thought to my trading routine and am always looking for ways to improve it.

What struck me as I read about his setup was how similar it is to mine - from the chart layout even down to the columns I sort by in my watchlist. The other thing that struck me was this quote:

Seriously, though, just a few stocks on a big watch list will trigger decent opportunities during a typical trading day. It’s our job to uncover these hidden gems and to avoid getting eyestrain looking at everything else. Sadly, this is a task at which most traders fail, i.e., they get so overwhelmed by randomness, there’s no brain space left for the real thing.

This underscores the main purpose of your trading desk - to allow you to easily focus on the small subset of data that you can profit from. This is the opposite of a lot of new traders that try to fill up their trading desk with as much data as possible as if they’ll miss something if they don’t cram 20 indicators onto a chart. There’s an infinite amount of data out there that you could look at. Your better off ignoring everything by default and deciding what not to ignore instead of the other way around.

Hat tip to Trader Mike for the article link.

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