It is a common practice to apply some strategies in trading in order to increase the chances of becoming successful. There are various strategies to choose from, yet there is no proven one that is applicable for all kinds of trades. How can we even be sure that these strategies are profitable for us? What are the ways to proving gainful strategies? In this article, we would talk about a technique in testing trading strategies called backtesting.
What is backtesting?
Backtesting is the process of testing a trading strategy based on past data to ensure that it is profitable. Backtesting software can be reconstructed with different situations to test the strategies’ effect in various conditions.
It gives out statistical results that can be used to determine the effectiveness of the strategy. If the results meet the set criteria, then the strategy is deemed viable. But if it ends up lacking in some parts, then it can be modified and adjusted to achieve the desired results.
The idea of this test is if a strategy has worked in the past, then it has a great possibility to also work in the future. The key is to test it out on all possible conditions that are likely to happen again later on.
Nowadays, a huge number of traders are opting to use computer automated strategies. To ensure the viability of these strategies, backtesting became an integral part of developing an automated trading system.
Significant backtesting data
There is a lot of backtesting software available on the internet that can be used to analyze strategies. Most of which can be modified to meet some conditions. A backtest should involve enough data to get acceptable results. For example, the duration of the sample time should be long enough to include periods of varying market trends. The sample size to be tested is also crucial because including only a small portion may not be statistically significant. Thus, backtesting should be optimized well in order to avoid making false conclusions.
Analysts should also take into consideration the gains and losses made throughout the whole time frame, the exposure or the percentage of the capital invested, wins-to-losses ratio, and the percentage of return over the course of the strategy.
Why is it important?
It is easy to pick a strategy or apply someone else’s strategy on our own trades, but we can’t expect them to work just the same as theirs. All traders have different preferences, trading lifestyles, and decisions. Backtesting, if implemented and applied properly, can help traders improve their strategies to become more profitable. That’s why it is important to apply a strategy that is drafted only for you.
Read more about the importance of following a trading plan.
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