Backtesting Your Trading

September 23rd, 2008

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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