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.
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 MACD histogram has crossed above the zero line and the DMI+ is above DMI-, go long when the 5 period moving average has crossed above the 20 period moving averages.
Sell short when the 5 period moving averages has crossed below the 20 period moving average and the MACD histogram has crossed below the zero line and DMI- is above DMI+.
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.
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.
One of the most important facts that you should always keep in your mind is that market change considerably overtime. A trading strategy that may have worked very well over the past three years may work in an entirely different manner for the next three years as the market changes and evolves.
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.
However, Backtesting is still the best available method for evaluating a trading strategy without actually trading it in real time environment. Backtesting can provide a trader with a reasonable expectation of the trading strategy's potential worth and usefulness.
Now let's discuss how to do Backtesting. Backtesting can be done by using two methods. The first one is the automated Backtesting. This 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.
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. - 31869
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 MACD histogram has crossed above the zero line and the DMI+ is above DMI-, go long when the 5 period moving average has crossed above the 20 period moving averages.
Sell short when the 5 period moving averages has crossed below the 20 period moving average and the MACD histogram has crossed below the zero line and DMI- is above DMI+.
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.
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.
One of the most important facts that you should always keep in your mind is that market change considerably overtime. A trading strategy that may have worked very well over the past three years may work in an entirely different manner for the next three years as the market changes and evolves.
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.
However, Backtesting is still the best available method for evaluating a trading strategy without actually trading it in real time environment. Backtesting can provide a trader with a reasonable expectation of the trading strategy's potential worth and usefulness.
Now let's discuss how to do Backtesting. Backtesting can be done by using two methods. The first one is the automated Backtesting. This 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.
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. - 31869
About the Author:
Mr. Ahmad Hassam has done Masters from Harvard University. Try This Cash Printing Forex Signal Service From Heaven! First practice on your Forex Demo Account!
