Essential Back Testing Software Knowledge
Back testing software is extremely important for the analyzing of trade systems. This is a process of testing out a particular trading strategy through the utilization of past date, instead of using real money and taking risks in real time. This is a way in which people can tell the way in which a strategy would work if it had been done in the past. This will give a trader the information he or she needs to determine whether or not it will be a feasible trading strategy.
Logically, we know that the results from this type of testing will not be able to predict future returns with pinpoint accuracy; however, it can provide an indicator as to whether you should even pursue a trading system or not. What's more, if you decide to go ahead and trade the system, it will give you guides on what to expect.
There are a number of things that you will have to ask yourself, one of which is whether or not you'll have the ability to examine system progression as time goes by. There are two basic ways of accomplishing this. The first way involves doing it manually, the second involves doing it with software. Personally I would do it with software, as it provides much more accurate results over a shorter period of time.
Do not underestimate or undersell the benefits of back testing software. Not only will it give you the time and opportunity to test out your system, it will also save you quite a bit of money in the long run! This is definitely a great thing to invest in if you want to create a useful and successful trading system.
Mechanical Back Testing
Please understand, as long as your mechanical trading system exclusively works with price data (open, high, low, close, volume), you will be able to use back testing software.
Here is an example of a rule that you might want to use with your mechanical system:
Buy a security as the ten day moving average associated with the closing price passes over the thirty day moving average.
Using this rule with historical data, it can be tested out fairly easily. If you buy signal rule however, it will be a bit more complicated:
Purchase a security when the 10-day moving average of the closing price crosses above the 30-day moving average of closing price and the PE ratio was 75% or lower than its value three months before.
A lot of the time you will fin that this rule gives data that is not present in the database. If you want to carry out this test accurately, make sure that you have the historical data of the security in addition to it's PE ration, or price earnings ration.
Unfortunately most mechanical trading system based on fundamental data is beyond the scope of retail investors due to the lack of historical data available to conduct a complete back test.
Back testing software
Fortunately, these days, many charting packages have back testing software built in. If you followed the process for selecting a charting package in the previous chapter, you should have either found one with back testing capabilities included or found one that is compatible with another off-the-shelf package.
TradeSim is probably the most realistic, true trading simulator/analyser I have found. It can quickly back test and evaluate a trading system, whether a single security or a multiple-security portfolio.
Back testing is the only way to get over your personal doubts in a system. When you've confirmed that your trade system is reliable, you will be comfortable with using it in practical trades.
Similarly to your charting software, make sure you know your back testing software back to front to make your trading system work. You won't be able to get the best out of it unless you fully understand how it works and what you can do with it.
Tags: back testing, trading system