Backtesting is the most under-utilized weapon in trading. It is the process of reconstructing historical data and testing your strategy over thousands of past trading chances to collect statistics about your edge.
Being a quant and systematic trader, any trading strategy you implement needs to go through rigorous backtesting. The underlying theory is to determine that any strategy that worked well in the past will likely work well in the future. With the data obtained from the backtesting software, traders can adjust their trading strategies to optimize their edge.
It is an essential tool that most traders don’t find out about or fully understand its importance until late into their trading journey. All great trading mentors will surely tell you about backtesting.
So without further ado, let’s discuss the top three reasons why all severe traders should use the backtesting systems.
Prove Your Strategy Works
There isn’t any system that worked without extensively testing it over historical data. Through the backtesting software, traders can test multiple strategies across multiple markets within a week and devise an entirely new profitable trading plan within a month or two as needed. This system allows you to collect a massive amount of data about your strategy with minimal time.
Backtesting historical data also allows you to witness how your plan will theoretically be performed in trading for the past few years. With this information, you can confirm whether what you plan to do in the market will help you make money or lose your money. Ideally, you will be able to tell whether or not the strategy you plan is viable within 100 trade tests.
Train Your RAS
The technical trader’s primary talent is to recognize trading opportunities. Without these skills, they cannot make money in the market. How do you develop this skill? Through repetition and practice would be your guess. But, trading and technical analysis are entirely different.
As a trader, a lot of what you do is mainly process-driven, such as risk-management and journaling. All they require is to execute self-discipline properly, which is quite different from your ability to recognize opportunities.
But sometimes, you need to recognize different patterns. It requires special attention to detail and knowledge of what to look for. You should know the difference between a bull flag and a bear flag or what zones are probably causing a price reaction. The only way to advance this skill is through practice. Train your reticular activating system to identify your edge patterns and occurrences much faster and quickly through backtesting.
Generate Trading Ideas
The fascinating thing about trading is the synergy of creativity with systematization. Backtesting is just like a mirror to reality. You might get the best trading idea in the world, but if it’s not profitable, then chances are it won’t suddenly start working now.
However, if you come up with a creative idea that you think probably doesn’t work, you may surprise yourself to discover that it does work through backtesting. With backtesting software, you can come up with an idea and then put it through the grinder. Whatever comes out is the thing to which you need to pay attention.
This will allow you to tweak and perfect your approach until you find a set of rules and filters that work and play to your psychological strengths.
Backtesting is one of the essential aspects of developing a successful trading system. It is the same as test driving the car before purchasing it from the showroom to decide if it is up to your expectation.
If it is created and interpreted properly, it can surely optimize and improve the trader’s strategies and find any technical or theoretical flaws. With backtesting, traders can gain confidence in their strategy before applying it to the real-world markets.