Backtesting

Yesterday, on a Sunday, I participated in the VectorVest Precision training workshop held in M Hotel.  About 150 people turned up, which was a full house, as the room that was booked was pretty small.  I was there, sharing on the topic of Backtesting.

I shall here put on this blog as an appetizer of what I shared during the event.

What is backtesting?  

To backtest, means to apply the trading signals of your trading system on past historical data. Most of the time, patterns repeat itself.  Past patterns that has worked in the past, may work in the future.

Backtesting forms an important part of my trading methodology. By knowing which strategies work well in the past, I will know which strategies have a higher likelyhood of working going forward.

What do we want to determine through backtesting?

The most important data that we need to know about our trading system are: 

1. the total gains vs total loss %
2. the number of of winners vs losers
3. the total number of trades
4. the maximum drawdown
5. Largest win vs largest loss

If you were to have the above information about your system, you will have a pretty good idea

1. of the expected annualized return of your trading activites
2. of the probability of winning for each trade you take
3. of the estimated number of trades you will be taking for the coming day/ week /month/ year, matches your trading psychology
4. of the downside risk to your total equity in trading the system
5. if your system is able to ride winning trades, and cut losers short 

Overcoming fear of pulling the trigger
I recalled, that there was once a time where I could not pull the trigger.  As I think back, there were many reasons for it.  Many trading psychology books has written about it.  I was a classic case of someone suffering from fear of losses.  It drove me nuts for a while.

Reading trading books, trading courses, were unable to help me.  Most of them do not reveal their backtest data.  The problem, I realized, was within me.  I got over that stage by doing extensive backtesting.  Eventually through backtesting, I became confidant in the eventual success of my trading systems.  This enabled me take every trade, knowing that even if I were to suffer consecutive losses, profitability will likely return in the long run.

Most trading software and systems sold do not have a backtest feature.  Even if it has, it is extremely difficult to use for a typical retail trader as they will likely require programming skills.

How do I backtest nowadays?

I am using VectorVest to backtest.  The great thing about it is that it is really just pointing and clicking through a wizard to generate the backtest that I want.  I can even test stops such as trialing stops, which is a pain to backtest via visual or manual backtesting through excel. See screenshot of the possible stops for backtesting.

Note : I am not paid for recommending VectorVest, nor am I earning any commission from their sales.