Backtesting Can Help Improve Your Manual Trading

October 29th, 2008

When I started automated trading a few months ago, I jumped head first into backtesting with the thought that it was essential to automated trading. While there’s no doubt that automated trading and backtesting go hand in hand, what I’ve discovered over time is that learning what makes automated trading systems tick (forgive the pun) gave me a much deeper understanding of the manual systems that I trade.

By learning how certain exit strategies affect the performance of high frequency automated trading systems, I inadvertently learned a lot about certain aspects of my manual system.

Some of my beliefs about my manual trading were reinforced, while other assumptions that I thought were practically 100% true were challenged by what I learn and continue to learn by backtesting automated trading systems.

For example, the time of day that you trade is absolutely critical. Strategies that make serious money at the open are often times completely worthless a half hour later (not all though).

There are other assumptions that I had about trend following systems and taking partial profits have been challenged.

One other thing I should point out is that sometimes taking the optimal action according to a backtest might not actually be the best course of action in your manual trading. For example, a backtest might tell you that taking partial profits (locking in a portion of your trading gains) is less profitable than not taking partial profits. What the backtest can’t calculate, however, is the peace of mind that can come from taking some of that profit off the table. Of course, we all probably make less than optimal compromises in our trading in exchange for some psychological comfort.

I’d highly recommend manual traders spend a little time backtesting strategies completely different than the ones they manually trade. Certainly if you’re a Trade-Ideas user already you should spend some time with the Odds Maker.

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