Know What Is Backtesting (Part I)
Backtesting any trading strategy allows a trader to simulate its expected performance using historical price data. With Backtesting, traders can actually test their trading strategies and know how well they would have done if executed in the past.
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.
However, using the past price data to simulate future results often misleads traders into thinking that their backtested results will also give 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.
So you should not fall into the trap of thinking that Backtesting may be a perfect method for identifying the most profitable trading strategies. Many potential factors can and will make hypothetical performance and actual performance differ significantly.
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.
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 in term of trade execution, a trading strategy in real time may be much different from the way the trading strategy behaves on Backtesting. These differences can potentially skew the results.
However, 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.
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. - 23305
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.
However, using the past price data to simulate future results often misleads traders into thinking that their backtested results will also give 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.
So you should not fall into the trap of thinking that Backtesting may be a perfect method for identifying the most profitable trading strategies. Many potential factors can and will make hypothetical performance and actual performance differ significantly.
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.
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 in term of trade execution, a trading strategy in real time may be much different from the way the trading strategy behaves on Backtesting. These differences can potentially skew the results.
However, 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.
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. - 23305
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!
posted by Mr. Forex at
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