The need to back test your trading system...

Whatever technical analysis criterion you use to trade with, be it moving averages, candle sticks, volatility breakouts, fibonacci retracements or any other trading system you have devised you're going to need to back test your trading system thoroughly and objectively in order to remove any possible doubt about it's capability.

To remove any self-doubt you need to thoroughly back test or simulate your trading system in such away that it matches the conditions under which it will be traded. Once you have established that you have a reliable and robust trading system only then will you be confident in trading your system.

The Importance of Back Testing

When trading what is the question in most traders’ mind? To answer this question I shall quote the introduction from Chapter 8 “Back Testing” of Mark Jurik’s book "Computerized Trading".

Will my trading strategy be profitable? After having gone through the arduous process of crafting a trading strategy, this is the question you must ask yourself. The ability to answer that question is the great promise that back testing holds out for all traders. A successful back testing procedure will greatly reduce the probability that you will begin trading with either an unprofitable strategy or one that does not meet your expectations. By adopting a sound and rigorous back testing approach, you will: -

• Pinpoint which approaches to the market that are likely to be successful and which ones are not.

• Generate good estimates of future performance for each trading strategy you test.

• Create a record of your trading strategy's historical trading performance.

• Produce data necessary for other components of your trading approach such as your asset allocation strategy.

Important Trading System Criteria

Profitability is not the only criteria by which a trading system should be evaluated. Drawdown and stress should equally be considered as well. Before you open a trading account, are you satisfied that your system is reliably profitable? Will drawdowns wipe out your account? Is your system trading in a way you can tolerate? Can you tolerate long periods of no trading or too much trading? Can you tolerate a large string of losses? The only way to answer these questions is to subject your trading system to extensive back testing.

Why simple back testers are just not up to the task.

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Last Modified on October 26, 2008