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Have you completed lesson 8’s action steps?
If not, complete those steps before reading on.
Secret Art of Back Testing
You would have to agree that any wise investor will do as much
testing as possible before starting to trade a system with real
money.
Back testing is the process of testing a trading strategy over
historical data to determine how well it would have performed
over that set of data. Interpreting these results then provides
the trader with sufficient information to assess the potential
of the trading system.
Logically, we know that the results from this type testing will
not be able to predict future returns. However, it can provide
an indicator as to whether you should even pursue a trading
system or not.
The truth of the matter is that whatever technical analysis
criterion you use to trade with - be it moving averages, candle
sticks, volatility breakouts, fibonacci retracements or any
other trading system - you're going to need to back test it
thoroughly, in order to remove any possible doubt about it's
capability.
Without back testing a lack of confidence arises and usually
forces traders to question their own trading systems. They give
into the temptation to modify their trading plan with devastating
consequences. This temptation spawns from a string of losing
trades or an opportunity to replace their trading system with
a whiz-bang indicator that is usually talked about in trader
chat forums.
Anything that sounds to good to be true will attract the attention
of any trader who is not satisfied with their trading system,
simply because they have not properly tested their system in
the first place. In addition, they have not built up the necessary
confidence needed to successfully trade the system developed.
In the end, negative subconscious thoughts will only hinder
and destroy your ability to trade successfully. To improve your
confidence in your trading system, you need to thoroughly and
objectively back test it - simple as that! Only then will you
be confident enough to commit time and money to it!
The Importance of Back Testing
When trading, what is the question in the mind of the most traders?
To answer this question I shall quote the introduction from
Chapter 8 “Back Testing” of Mark Jurik’s book "Computerized
Trading".
- Will my trading strategy be profitable? After having gone
through the arduous process of crafting a trading strategy,
this is the question you must ask yourself. The ability to answer
that question is the great promise that back testing holds out
for all traders. A successful back testing procedure will greatly
reduce the probability that you will begin trading with either
an unprofitable strategy or one that does not meet your expectations.
By adopting a sound and rigorous back testing approach, you
will:
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Pinpoint which approaches to the market that are likely to be
successful and which ones are not. |
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Generate good estimates of future performance for each trading
strategy you test. |
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Create a record of your trading strategy's historical trading
performance. |
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Produce data necessary for other components of your trading
approach such as your asset allocation strategy. |
... But the question remains, how can you test a trading system's
performance over time? There are only two ways to do this, manually
or with computer software. To be honest, computer software is
the only “real” option. I have done both testing methods and
manual testing is not only time consuming but very hard to replicate
and test effectively.
The benefits obtained from back testing software cannot be underestimated.
It will save you time and provide an endless opportunity to
fine tune and test variations of your ideas. A small outlay
in capital to purchase good back testing software will potentially
save you thousands, in the market; it is a very wise investment
if you are considering designing a successful and mechanical
trading system.
For those of you who decided to purchase MetaStock you choice
is easy… I have done the research and found the first realistic,
true trading simulator/analyzer for Metastock that can quickly
back-test and evaluate a trading system across a portfolio of
securities. It’s called Tradesim.
In short, TradeSim can evaluate the historic performance of
a given trading system within a matter of minutes and do it
with a realistic representation of a real-life trading scenario.
Whether a single security or a multiple security portfolio,
TradeSim answers the simple question:
"What would of happened if this system had of been traded in
the past?"
Sounds simple - but it is extremely complex, if not impossible,
to do with most charting packages as it stands. However, with
TradeSim it is just a simple matter of running it alongside
Metastock and analyzing the resulting trade data.
Don’t take my word for it though… here’s what one trader said:
"I have read dozens of books on trading, subscribed to various
newsletters and attended countless seminars, so I thought I
knew it all. That was until I purchased Tradesim Professional
and boy was I in for a real shock. Believe me when I say this,
TradeSim is the best teacher by a long mile..."
J.B - Washington, USA
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With TradeSim, Metastock becomes more powerful than it ever
was - even rivaling trading packages costing many thousands
of dollars!
You are probably not aware that to approach the functionality
and power that TradeSim adds to Metastock, you would need to
spend many thousands of dollars to get the combination of both
packages put together. Even then, competing packages fall quite
short when it comes to analysis power and options, as well as
simplicity of operation. TradeSim was built right from the ground
up with the professional trader in mind!
Your system may look good…"But what about its real world trading performance?"
Typically your system will consist of entry and exit triggers
as well excellent money management rules. These parameters
basically define a framework for a trading system. The trouble
with trying to back test a trading system with most other packages
is that they provide an extremely limited interface. As a result,
with these other packages, you’re given a distorted view of
your potential trading system’s performance.
TradeSim addresses all of the above issues, whilst exploring
new ground in technical analysis it also uncovers new issues
that have not been addressed by current software technologies.
For the first time you can back test your trading system the
way you would trade it and objectively analyze its performance!
This really is the final step in designing a trading system
yet very few traders have the knowledge or patience necessary
to test the profitability of a trading system.
I believe back testing is the only way to remove self doubt.
Once you have established that you have a reliable and robust
trading system only then will you be confident in trading it.
Your next step is to buy yourself a backtesting package - I
recommend TradeSim. When you’re ready, in the space below, write
down which backtesting software you plan to use:
The final piece in the system design jigsaw puzzle is to take
the trading system you have designed in the pervious chapters
and test it. By testing your system s you have just put yourself
into the top 1% of traders. Congratulations!! You are there!
Let’s get your psychology right.
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MUST
DO ACTION
STEPS:
- Purchase a back testing package - Click Here to purchase
TradeSim.
- Back test your newly designed system including your entry, exits, and money management rules. If you need help on this topic visit www.meta-formula.com
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A Final Word Of Warning:
If you find yourself testing and testing in the hope of stumbling
across that magic secret that will unlock the market and all
its profits. Remember, you will never create a trading system
which has a 100% success rate. Many have tried and many have
failed.
You should be looking for a good trading system with minimal
draw-down and a good reward risk ratio. Many trading systems
have more losing trades than they do winning and yet they still
makes money. How? Well, as you learnt in Trading Secrets Revealed,
the holy grail of trading is your Money Management.
Are You Ready To Move Onto The Next Lesson? Click
Here...
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