A . trading strategy is determined systematic method Buying and selling financial assets based on specific rules set by the trader.
For example, a trend-following trading strategy It involves buying and selling when there is a pre-existing trend.
To have a successful career, it is not enough just to take and adopt a strategy. We must too Try it and try again to make sure it works. In this article we will explain How do you backtest a trading strategy we will.
What is a backtest?
Backtesting is The process by which a trader makes a trading strategy and Uses historical data to estimate profitability of approach.
It’s common apply strategyeither manually or automatically, to a real world. The idea is that a trading strategy that has done well in the past will lead to a better result in the future.
It is always recommended to back-test the strategy Before applying it to a real account. In most cases, this usually happens on a demo or demo account. The demo account is a trading account for him Real data and virtual cash.
It is noteworthy that the back-testing of the strategy Not always a guarantee it will produce Strong results in the future. In some cases, the strategy can work well in a back-test environment and then fail in a real-world environment.
In most cases, backtesting is related to the automated trading system or a robot. A robot is a piece of software that analyzes and then executes trades. It can also set stop loss and take profit to properly manage risk.
Owns most trading platforms such as MetaTrader and TradingView Inbuilt Tools To backtest automated robots. Their back-testing tools are so sophisticated that they can be easily manipulated to handle these tests in many ways.
Backtesting vs. paper trading
Backtesting and paper trading Often used interchangeably. However, there is a difference between the two. As described above, back test It is the approach where you have a trading strategy and test it Using historical data.
paper circulationknown as demo trading, is a process in which You are using a demo account to make trades. It is mostly used to create a trading strategy and to simulate How would a trader perform in a real account?
Related “ How to switch from paper trading to live trading
Why you need to back-test your strategy
Backtesting is an important thing any trader should do. The many benefits of doing this are:
- future performance simulation – It makes it possible to simulate the future performance of a trading strategy.
- There is no risk of capital – Backtesting in the demo account allows the trader to try different scenarios without putting his or her capital at risk.
- Modify the strategy – It gives the trader the opportunity to modify a strategy without risking his capital. For example, a trader can test different periods of moving averages to determine which are the best performers.
There are three main types of backtesting in day trading, including:
- replay Rebooting is a kind of back-test offered by most trading platforms. Makes it possible for the merchant Live market environment simulation Based on previous trading data.
- encrypted This is a back-testing strategy It is popular among algorithm traders. In it, they run different types of simulations to determine the likely predictions of a trading strategy.
- manual – This is the most common backtesting approach. It’s common Come up with a strategy and then simulate its performance manually. For example, you can decide to focus on the triangle pattern and come back to see how it has performed historically.
How to back-test a strategy
A common question among many traders is how to make a good backtesting trading strategy. Here are some of the most important steps to take when testing the effectiveness of a strategy:
Develop a trading strategy
This is the important stage you reach A strategy based on your preferences. Some of the best trading strategies you can use are: double moving averageAnd the bollinger bandsAnd the Follow trendReflection, Algorithm. You can develop a manual or automated trading strategy.
Use the strategy test
If you choose an automated strategyNow you need to use the strategy tester tool provided by your trading system. For example, the chart below shows the result of testing the strategy on the MT5 trading software.
In this chart, we are testing the moving average strategy on the EUR/USD pair.
In this chart, we can see several important data points to enter when backtesting a trading strategy, including:
- a period – This refers to a period when you back-test the strategy. In most cases, the period should be relatively close. In a while, you should Choose the exact period based on your trading strategy. If you are using the hourly chart, you should always backtest on the same chart.
- Delay Delays refer to the period or delay of implementation.
- deposit– You can put an unlimited amount of money into a demo account. However, you must backtest using the specified amount that you trade with.
The chart below shows the results of the backtest. These results show that the strategy incurred a net loss of $195.
Modify the strategy
Finally, you have to adjust the strategy and do back-testing again. For example, if you are using a 25-day moving average, you can change it to 20 and see the backtest result.
Backtesting Strategies and Rules
There are many unwritten rules for back-testing a trading strategy. some of them:
- Don’t be in a hurry You should always take your time to test the strategy. In most cases, you should take at least two weeks to do this.
- Uses same assets You are trading – always do backtesting on the same assets you are trading. If you are trading the EUR/USD pair, do a backtest on it.
- a period As mentioned above, you should always focus on the period you are using to trade. If you are using the hourly chart, you should always back-test it.
- Add pricing – You should always add prices and all costs involved in executing deals.
Pros of backtesting
- trade without risking capital.
- Automated strategy tester is Fast and easy to use.
- makes it possible Adjust the trading strategy.
Disadvantages of backtesting
- this is Not an accurate method From Performance Measurement from an asset.
- Historical data is not always a good indicator for future performance.
- Market conditions tend to change on a regular basis.
- Sometimes, There may be insufficient data To do this reverse test.
questions and answers
Why is backtesting important?
It is important because it makes it possible to see the performance of the bot without risking your real capital.
Is a retrospective test necessary?
This approach It is a must for any trader No matter what strategy they use. It can help them determine if a trading strategy is effective or not.
How much backtest is enough?
You should take enough tests so you can be sure That trading strategy works. In most cases, you should try to test it in all market conditions.
What is the difference between backtest and forward test?
Backtesting is the difference from forward testing. Backtesting uses historical data to measure strategy performance. front teston the other side, uses simulation for future data.
Whether you are just beginning your career as a trader or already have experience in the markets, you cannot overlook the practice of backtesting.
Testing new strategies or trying to improve your own over time is essential for any trader to adapt better to any situation in the market. Being able to do this without risking money – even with historical data – is a must.
Useful external resources
- What are good ways to back-test a trading strategy and how to do it? – kora