Back Testing Software - What Is It?
February 7, 2010 – 4:30 pmCreate a Profitable Trading System
When you want to analyze different trade systems, back testing is the way to go. This is basically where you test your strategy using a trade that has been conducted in the past. By doing this you do not risk real money, and you as the trader will be able to determine whether or not it will work in a real financial situation.
While you aren’t going to get results with pinpoint accuracy, you will at least have some idea as to whether or not it is a good trading strategy. You will also know what sort of results you can expect to see when you proceed with the given strategy.
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.
The benefits derived from back testing software cannot be underestimated. It will save you time and provide an endless opportunity to fine-tune and test your system. A small outlay in capital to purchase good back testing software will potentially save you thousands in the market; it is a very wise investment if you are considering designing a successful and mechanical trading system.
Mechanical Back Testing
Keep in mind that if your mechanical trading system works exclusively with price data, back testing software will be a viable option.
Here is an example of a rule that you might want to use with your mechanical system:
Purchase a security when the 10-day moving average of closing price crosses above the 30-day moving average of closing price.
By utilizing this particular rule using historical date, you will find that the back testing is pretty easy. Signal rules on the other hand are a bit harder:
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.
Many times this rule will provide information which is not included in the database of price information. In order to do this test properly, you would need historical data of a particular security and it’s price to earnings ratio, which is also known as the PE ratio.
The biggest issue is that many investors cannot use the mechanical trading systems because of the lack of historical data. This data is needed to complete the back test.
Back testing software
As luck would have it, the majority of chartering packages these days have back testing software included. In the chapter preceding this one, there was a process for choosing a good chartering package, and so long as you followed it to the letter, you likely found one that either has it’s own back testing features, or at least one that is compatible with other back testing software.
If you’re looking for a decent piece of software, you should definitely have a look at TradeSim. It can help you back test and check out a trading system with relative ease. Regardless of whether or not you’re dealing with a single security, or an entire portfolio.
The only way to clear up your doubts and get to using your system is to complete your back testing procedure. Once you’ve figured out that your system is stable and reliable, it will be time to proceed with the real trading!
Your trading system however will not thrive unless you choose back testing software that is reliable and rock solid. In addition to it’s stability, make sure that you are able to learn it and take full advantage of it’s features.