How to Back Test Your Trading Strategy – Many traders never bother to back test their trading strategy.
They either don’t know how or believe that it’s not necessary.
This is a huge mistake! If you want to be a successful trader, you MUST back test your trading strategy.
Checkout this video:
Define what you want to test
The first step is to define what you want to test. Some things you may want to consider are:
-What time frame will you use?
-What entry and exit rules will you use?
-What position sizing rules will you use?
-Will you use stop losses? If so, where will they be placed?
-Will you take profits at pre-determined levels or let the trade run until it hits your stop loss?
-How will you deal with slippage and commissions?
Answering these questions will give you a good starting point.
Choose the right data
Not all data is created equal. When you backtest your trading strategy, you want to use high-quality data that is as close to reality as possible. This will help ensure that your results are accurate and that you can trust your strategy.
There are a few different sources of data that you can use for your backtesting:
-Historical data from your broker: This is the simplest and most common way to get data for backtesting. Your broker likely has a platform that allows you to download historical data for the markets you want to trade.
-Third-party data providers: There are a number of companies that provide historical market data. This data is generally of high quality, but it can be expensive.
-Free market data: If you want to save money, there are a few sources of free market data. However, this data is often of lower quality and may not be suitable for all types of strategies.
Once you have your data, you need to decide how far back you want to go. A longer time frame will give you more data to work with, but it will also be less representative of current market conditions. As a general rule, it’s a good idea to go back at least a year, and preferably two or three years. This will give you enough data to see how your strategy performs in different market conditions.
Set up your test environment
There are two main ways to back test your trading strategy: manual back testing and automated back testing.
Manual back testing involves taking your trading strategy and manually executing it on historical data. This can be done on paper or using a software simulator. The advantage of manual back testing is that it allows you to get a feel for how your strategy would have worked in different market conditions. The disadvantage is that it can be time-consuming and may not be as accurate as automated back testing.
Automated back testing involves using software to execute your trading strategy on historical data. The advantage of automated back testing is that it is much faster and more accurate than manual back testing. The disadvantage is that you need to have access to high-quality historical data and you need to have a good understanding of how to use the software.
Write your code
In order to back test your trading strategy, you will first need to write the code for your strategy. This can be done in any programming language, but many traders prefer to use a language like Python or R because they are easy to learn and they have many libraries that can be used for data analysis. Once you have written the code for your strategy, you will need to test it on historical data.
Run your test
To actually run your test, you need market data. This data can come from a broker, through a subscription service, or even from a historical data provider. Once you have your data, you need to load it into your testing platform.
Your testing platform is the software that will simulate trades based on your trading strategy and historical market data. There are many different testing platforms available, both free and paid.
Once your data is loaded and you have your trading strategy ready, it’s time to start simulated trading! Most testing platforms will allow you to trade “live” as if you were actually placing orders in the market. You can also test over different timeframes, such as 1 day, 1 week, 1 month, etc.
When your test is complete, you’ll want to analyze the results. Typically, you’ll want to look at things like your win rate (the percentage of trades that were profitable), your average profit/loss per trade, and your overall profit/loss for the entire test.
If you’re happy with the results of your backtest, then it’s time to start live trading!
Analyze the results
After you have run your back test, it is time to analyze the results. The first step is to take a look at the overall performance of your strategy. How did it do? Were there any losing streaks? How large were the drawdowns? Next, you will want to look at the individual trades. Which ones were winners and which were losers? Were there any trades that were particularly close?
Once you have a good understanding of how your strategy performed, you can start to tweak it. Maybe you can add a filter to reduce the number of losing trades. Or maybe you can change the entry or exit criteria. By constantly tweaking and testing your strategy, you can improve its performance over time.