Becoming a professional trader in today’s world is not easy. The competition is tough, and you will have to invest a lot of effort to become better than your competitors. However, the good news for you is that you are living in the 21st century. The online world is full of information that can help you improve your trading performances. One of the ways to do that is by backtesting your trading strategy.
We are sure that many people haven’t even heard about backtesting trading. That is the reason why we would like to make an in-depth analysis of the subject. There are many pieces of information you should know about backtesting trading. Despite that, you should also learn how to properly backtest a trading strategy. The process is not challenging, but it deserves a bit more attention. You can also check websites like admiralmarket.com to gather more information on the same topic. Doing that will allow you to improve your knowledge even more. Let’s get started!
Before Everything – What Is Backtesting Trading?
The trading strategy of every trader needs to have a set of specific rules. That is the only way to complete the backtesting successfully. There are many ways of how you can determine those set of rules. The traders have the option to complete the process manually. However, they can also use the automated trading strategy where computer algorithms play the key role. Both approaches have different requirements, and you should know them before deciding on one of them.
By choosing a manual trading strategy, the trader analyzes the history of all the trades he made. He looks for those trades that are matchable with his trading strategy rules. Logically, the next step he needs to take is to record all the data he managed to find.
After recording data, the trader has a clear picture of the failures and successes he made in history. Despite that, he can also calculation the win to loss ratio, determine the largest mistakes he made, etc. All these pieces of information will confirm if the system he developed is effective or not.
On the other hand, many traders will consider automated trading strategies less challenging. They often use platforms like MetaTrader 4 and MetaTrader 5 to complete their part of the job. Whichever platform you use, the entire process is the same or almost identical. You primarily need to program the trading system on the platform. Thanks to algorithms that the program uses, you will manage to find all the trades that meet your set of rules. For a short period, you will get a full report and insights into all the trades you previously made.
So, How to Backtest a Trading Strategy Properly?
The short answer to that question does not exist. People need to go through a couple of steps before they reach the final goal. We recommend you read our list carefully and apply every step.
First Step: Build a Trading Strategy and Determine the Rules
We will start from the very beginning. Developing a trading strategy is a challenging task. You will need to answer a couple of questions before doing that.
Before everything, it is essential to determine the instruments you will trade on. In other words, you will have to identify the market that meets your expectations. Keep in mind that the same strategy can’t bring the same results on the same market.
After that, you need to determine the time frames you will trade on. Beginners and less experienced traders make a common mistake. For example, they backtest the strategy on a daily chart and expect to trade it on an hourly chart. By doing that, you will get confusing and complex results that won’t raise your profit in any way. That is the reason why you need to identify your time frame. It can be a ten-hour or five-hour chart, it doesn’t matter.
The third step is identifying the tools you will use for selling and buying processes. Reaching the right tools is possible in several different ways. For instance, you can get a clear answer from fundamental analysis as well as technical analysis. If you decide on, for example, technical analysis, you will have to use trading indicators and chart patterns. Thanks to these two tools, you will manage to make further trading decisions. By identifying the tools, you will know at every moment what you are looking for.
Finally, determining the risk management is the final standard you need to determine. Each trade requires a certain level of risk, and you need to know that level at every moment. Despite that, you have to determine the right moment to stop loss and take profit. All these pieces of information are essential for the backtesting results.
Now, Start the Process
The previous four-step will allow you to properly backtest a trading strategy. More precisely, it will allow you to precisely define all the trading strategy rules. That will help you check the historical trades properly. The best possible way to record the data is by using Excel spreadsheets. In that way, you will manage to filter the most effective performing days and highlight all the losing and winning trades.
You are not going to see the successful days or months in the Excell spreadsheets. The traders can also see how successful their entire trading strategy is. Despite that, you will also see which trading decisions you made were distracting you from reaching the goal. These insights are going to be the best possible lessons you can get. Analyze your mistakes, and determine reasons why your trading was not on the highest level during days. Despite that, check out if the trading strategy you established can bring long-term success.
Measuring and analyzing previous trades are the key factors that influence your success. You need to understand that not measuring different parameters will distract you from your main goal. Despite that, it will make you less competitive on the market. Your biggest competitors are backtesting their trading strategies continuously. Because of that, they will always be a step ahead of you.