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Trading Systems – Crucial Facts On Back Testing

March 26, 2011 — 11:18 am

If you’re into stock trading, one of the first things you should really look into is back testing trading systems. Sadly, not every trader puts as much importance on this as they should. Before you make any decisions about it yourself, there are a couple of important points about the procedure that you should clearly have in mind.

#1- You can’t skip tests and expect to win in trading.

You may have heard seasoned traders say that success lies mainly in having a trading system. In reality though, it isn’t enough to simply have a system or plan in place. The real element that can make you a true winner is if you follow a system that has been tested. The key to winning big in the markets is to back test.

To say it quite plainly, you can’t expect to reach any dramatic profits if you don’t start testing your system. The explanation behind this is that testing is what can help you see if a system can function well in market conditions. Instead of experiencing firsthand the level of effectiveness of your system in an actual trade and potentially lose money, you can check it before you trade for real.

#2- You don’t need to spend real money in the act of testing.

You obviously need to shell out some cash to get your hands on a testing tool but other than this, back testing isn’t too costly. You don’t need to use real money when you test your trading plan. This is because only historical trading information is used to check on system performance. What you will get then is a view of how well your plan will function when traded using historical data.

Understandably, you might feel a bit sceptical over the accuracy of test results. After all, how can it provide you with good insights if current market information is not taken into consideration? There is no real need to test using real data. Pieces of past trading information are good enough to use for gauging system value.

#3- Everything hinges on the software.

Just like most everything else, back test tools aren’t all equal. You need to find one that is good enough for your needs. Charting software sometimes come with their own testers but you need to look at what is actually being offered. If the default tool can’t test systems across a diverse trade portfolio, it might not be good enough for you. Third party testing facilities are often best.

#4- You can’t create a flawless system based on testing.

There are some traders who use testing tools so they can tweak their systems to perfection. Before you attempt the same thing, you should know right now that this just is not possible. There is no perfect system that will completely eliminate trade losses. What you should really focus on is finding a test tool that can help you pick a system that will only generate minimal draw downs.

With so much at stake in stock trading, you can’t afford to belittle back testing. Before you start your own trading account, running tests on your trading plan is the one thing you can do to make sure you don’t go down the loser’s path.

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Stock Trade Tips for More Profits

October 15, 2010 — 1:52 am

Some trade tips on trading systems are not worth paying attention to because they can make you lose more than you win. They may be incorrect pieces of advice. It’s also possible though that they offer sound advice but you’ve simply neglected applying basic principles. Before you jump on advanced trading advice, make sure you are taking the appropriate first moves.

#1- Focus on a market.

If it’s your first time to invest, the first real decision you have to make is to determine the market you will be investing in. There are several investment markets but it is best to at first hold off investing in multiple markets. This is because it is already a mouthful to try and sink your teeth into one market. Imagine how things can become more stressful if you try to master multiple markets. It is often a sensible idea to start with stock trading. These assets are not leveraged. What that ultimately means is that you stand to lose less than if you started trading leveraged assets. After hurdling the challenges of the stock market, you could consider moving on to other market types.

#2- Create a personal system.

Some traders skip drafting a plan or system. This may be because they are more comfortable making trades based on what they feel is profitable. Following a system however is almost always best it can help you think in a logical way. This is because systems organize your entry and exit points based on standard rules. You can base your system on some popular ones that are already available. You should however try your best to customize the insights that you pick up to match your risk management preferences.

#3- Test your system.

Some trade tips from investment experts mention system creation well enough. They sometimes forget to mention back testing though. You may have a system that you think suits you well. It might end up becoming a useless system though if you do not check if it works or not. One way to do that is to go for back testing. This is a way of testing how your system performs using past trading data. If it works well with previous data chosen based on your criteria, it has a high chance of performing well for you in the future.

#4- Stand by your plan.

Sometimes the problem is not the system at all. You may have an excellent plan but still end up without any profits. One probable reason for this is because you don’t have the commitment to keep to your system. Once a system is back tested, you should have some assurance that it will work. This means there is no reason for you to jump ship at the slightest sign of an impending loss. If you ride through the losses long enough, you will eventually see a good system work. Give it time to help you rake in some profits. Promise to stand by it no matter what happens and you’ll see that things will work for you.

#5- Get charting software to work full blast for you.

Every trader needs charting software. This is an important tool that can help you both store pieces of information and analyze them. Most good software tools are too technical and difficult to figure out. It would be a pity though if you were only able to use your software for looking at charts. Use your tool to the utmost by using third party resources and materials that will help you make sense of it.

There are a great many trade tips. Keep these basic ones in mind though to ensure that you will always be on the right path to fantastic profits.

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Stock Charting Software- Age is an Important Quality

September 18, 2010 — 11:41 pm

There are a number of different qualities you can check to find an ideal charting software package. One important trait to settle for is longevity. The package that you should choose should have been around for quite some time already. There are distinct advantages to choosing an old trading chart product.

The first good reason to choose an old, established package is that its age offers some certainty of effectiveness. You can expect a package to be effective if it has been around for long simply because it flies against the face of logic for software owners to continue to support and develop a product that does not generate income for them. Hence, stock charting software that has been in use for years indicates that it is effective enough for people to continue buying it and for developers to maintain it.

Longevity is also an important quality to look for because a product that has been around for years is likely to have a long standing support system as well. You can expect this system to have comprehensive and well developed processes that will stay on for many more years. You’d want this simply because it can be a nightmare to settle for a newly made package that suddenly drops out of the market, taking with it its support system. Hence, even if you are able to continue using a defunct charting software package, you will lose access to updated support in the long run.

The developer support system is not the only thing to look forward to in an old product. Aged packages are also better deals because of the wide user base that can function as back up support. In case you can’t find answers in the help topics, you can always contact actual users in forums and ask for assistance. An additional benefit to this is that you gain a lot from volunteered information. Expert users love to post what they know so you can expect a few gems here and there when it comes to advice on using a chart product, trading systems and back testing. You can even post your own tips and gain a following as an expert user.

The broadness of the user base suggests that a stock charting package is a good focus for developers of related tools. This is to your advantage because developers who want to cash in on the next great piece of software can develop tools that can greatly improve your user experience. Usually, tools created by third party developers are back testing and data source platforms.

As most experts would know, data sources and back testing tools are vital in the smooth and effective implementation of trading systems. Trading gurus suggest that only back tested trading systems that have been evaluated through the use of accurate historical data should be adopted. Charting products can have their own test and data tools. Those from external developers however are often better made.

Your stock market charts software is vital to helping you build a profitable trading career. This is why you should take the time to look for a chart product that has earned its stripes through time and use it with an equally established plan like the Nicolas Darvas trading system. With your career and capital on the line, you can’t risk making a bad choice.

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Forex Backtesting

September 17, 2009 — 12:11 am

What is Backtesting? You must have read a lot about the backtested performance of  trading systems on websites. With Backtesting, traders can actually test their trading strategies and how well they would have done if executed in the past. Backtesting any trading strategy allows a trader to simulate its expected performance using historical price data.

Now an important question that comes to anyone’s mind is what type of a trading strategy can be backtested? Any trading strategy that does not have any ambiguity in its rules can be backtested effectively. Example of a simple trading strategy that can be backtested can be as follows.

When the DMI+ is above DMI- and the MACD histogram has crossed above the zero line, go long when the 5 period moving averages has crossed above the 20 period moving averages. When DMI- is above DMI+ and the MACD histogram has crossed below the zero line, sell short when the 5 period moving averages has crossed below the 20 period moving averages.

Are backtested trading systems reliable? Why so much backtested performance is quoted on the websites to prove that the trading system is good? You must know that using the past price data to simulate future results often misleads traders into thinking that their backtested results will also give into similar results in actual real time trading. This one example is just meant to illustrate that any trading strategy having clear cut rules can be backtested with the historical data.

There is much difference between live trading performance and the backtested trading performance. Many potential factors can and will make hypothetical performance and actual performance differ significantly. So you should not fall into the trap of thinking that Backtesting may be a perfect method for identifying the most profitable trading strategies.

Market fundamentals keep on changing. This makes a trading strategy that may have worked very well over the past three years work in an entirely different manner for the next three years as the market changes and evolves. One of the most important facts that you should always keep in your mind is that market changes considerably overtime.

Technical indicators also need to change with the market. Do you know that often technical indicators that have been giving profitable signals in the past are subsequently unable to replicate their performance in the future? This may frustrate you. But this is exactly what makes trading a challenging endeavor.

Secondly, real time trading and trading with the past historical price data are two different things. A trading strategy in real time may be much different from the way the trading strategy behaves on Backtesting in term of trade execution. These differences can potentially skew the results.

YouTube Preview ImageHowever, you should still not underestimate the benefits of Backtesting. Backtesting can provide a trader with a reasonable expectation of the trading strategy’s potential worth and usefulness. Backtesting is still the best available method for evaluating a trading strategy without actually trading it in real time environment.

What are the methods to do Backtesting?  Backtesting can be done by using two methods. The first one is the automated Backtesting. The second is manual Backtesting. Automated Backtesting is the most popular method. Automated Backtesting entails using a specialized program. The trader inputs the specific rules and criteria for the trading strategy into the Backtesting program.

Automated Backtesting is very easy. An entire picture of the past performance is created with the help of that software program. The software automatically applies those rules to the past price data and tallies the past hypothetical profits, losses and other information. 

The second method of Backtesting is performed manually and visually by the trader. Why would someone do a manual backtest? There are difficulties in doing Backtesting manually but at the same time there are a few advantages of Backtesting. The trader would take the historical data and scroll back in time on a chart and manually apply the trading strategy as if it was in a real time environment.

One of the major drawbacks with manual Backtesting is hindsight. How to eliminate the hindsight factor while doing manual Backtesting? The trader would advance the chart bar by bar in order to refrain from seeing price action subsequent to the trade at hand. This eliminates trading in hindsight that is detrimental to an objective backtest.

The major disadvantage of Backtesting as compared to automated testing is the significant potential for human error in executing simulated trades and recording performance results. Manual Backtesting is complicated and difficult. It requires a lot of patience on part of the trader.

Emotions are your enemy in trading. When you do manual Backtesting, these emotions can cause problems for your Backtesting results. The normal range of human emotions and biases that often interfere with actual trading can be a detrimental factor in achieving objective backtest results. Furthermore, it takes a great deal of work and discipline to simulate trades manually over a large data set without straying from the strict rules of the trading strategy.

These were some real disadvantages of manual Backtesting. However, this provides valuable trading experience although simulated but still a valuable trading experience that no automated backtest could possibly provide. Backtesting manually can provide the trader with the real feel for actually trading the strategy.

No matter whether you do Backtesting manually or automatically, Backtesting can save traders a great deal of time and money that might otherwise had been wasted on trading unprofitable strategies. Backtesting whether done manually or automatically can be one of the most important elements of building a solid trading strategy. Backtesting is now an important element of testing a trading system performance.

You must have heard a lot about the benefits of autotrading. Autotrading is the latest fad especially in forex trading where the number of major currency pairs is only six. This makes programming forex autotrading easy. Any mechanical trading system can be backtested. This leads us to the important question of autotrading. These autotrading systems are popularly known as Expert Advisors or Forex Robots.

In contrast, stock autotrading systems can be big more complicated. The US Stock Market has got more than 50,000 stocks listed with them as compared to the forex market where there are not more than six major currency pairs. This makes programming a stock trading robot a bit complicated. However, during the past decade major breakthrough in computer programming has been made.

An autotrading system needs to be thoroughly tested before being put to live test. The only way to do this is through Backtesting. Backtesting is one of the most important components of testing an autotrading system. Big institutions like banks, corporations and hedge funds have always been taking benefit of these autotrading systems. 

So what type of trading strategies can be backtested and autotraded? Any trading strategy that is rule based and is not discretionary or discrete. These types of strategies are primarily technical in nature, and they must necessarily have rules and criteria that are unambiguous. Backtesting and autotrading are two important components of implementing trading strategies that generally do not rely upon the trader’s judgments or discretion.

Backtesting gives you the benefit of testing your trading system on a large historical dataset. Backtesting allows the trader to determine if a given strategy would have been profitable using past price data, which is an indication of how it might potentially perform in the future. In contrast, autotrading actually executes real trades automatically according to a pre – programmed set of instructions that sets trade entries, stop losses, and profit limits.

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