There is a lot of information that one must process before getting into trading. For starters, you should have a thorough understanding of the trading world, beware of how to actually trade, when to do it and when to abstain from trading. All this is generally done to ensure that you are making meaningful gains in the trading arena.
Backtesting trading strategies is a means of ensuring that whenever you trade, you won’t just be making blind moves in the market. Once you have understood all the facets that pertain to trading, then you can apply software applications to help you trade.
Trading strategies take a lot of time to complete. Such an approach defines how you enter a trade as well as your expectations from the venture. Before launching the strategy, you need to test it out so that you can protect yourself from potential lossmaking and eventual failure in the trading scene.
What is Backtesting, and why traders require it?
Backtesting is a means to test out your trading strategy and see how it performs when subjected to real trading data. Typically, backtesting makes use of historical data from previous years and puts to work your trading strategy. You will then have a general idea of how it would’ve performed in the selected timeframe.
Once you complete backtesting, you can then engage the trading strategy in a forward test. The latter uses real-time data as opposed to historical data. However, you will have to get by the backtesting step to consider forward testing.
Back in the day, when computers were still unheard of in global markets, backtesting was quite easy. However, the workload involved was daunting going by today’s standards.
Traders would draw up their diligent trades on charts and effect a buy or sell action. Once this was done, they would then comprehensively note the trade results into a log for recording.
All this was done manually as there were no computers back then. If you could display the results on a computer screen, you would be ages ahead of the rest.
Today, on the other hand, computers are the basic tools used in trading. Therefore, backtesting is a lot easier than in previous years. They have improved the efficiency and potency of trading strategies the world over.
Why traders need to backtest their strategies
Before you enter a trade, you need to backtest your strategy. Failure to do so could spell significant consequences, not to mention burning your account. However, this is basic knowledge. Backtesting could prove useful to your trading future especially if you got into trading as a long-term investor.
· Strategy
Needless to say, backtesting evaluates your trading strategy. From a successful backtest, you will know whether whatever you developed would have returned a profit, or would it have performed contrary to your expectations.
Afterward, you can then evaluate the entire approach where need be or refine it all together. Either way, backtesting serves as a means of improving any trading approach for the better.
· Experience
During backtesting, you get your strategy working on real data, albeit from the past. Either way, you are sort of going to be involved in trading, or historical trading if you may. Manual backtesting is a particularly reliable way of gaining meaningful experience in the trading business.
· Confidence
With every successful strategy backtest, your confidence as a budding trader receives some much-needed boost. Since you will be trading with actual figures drawn from the past, every successful strategy means a potentially successful trade. Even though you aren’t using real-time data, the next time you trade with live figures, you will have some experience and this is key to trading.
Ways to backtest your trading strategy
Once you have developed a potential strategy that you believe to be the real deal, it is time to test it out. There are several ways to backtesting trading strategies. They are mainly divided into two methods; manual and automated backtesting.
· Manual backtesting
Manually backtesting a trading strategy, however, you view it, is pretty exhausting. However, this method provides traders, especially beginners with a real feel of how the market works. If you are looking for some practical experience in trading, manual backtesting is the way to go.
Follow these steps to backtest your trading strategy manually:
o Step 1
Obtain a trading chart that is easy to read and feed in the desired currency pair you wish to backtest on. If you have any indicators or tools that make up your strategy, include them on the chart. Roll the chart back several periods.
o Step 2
Shift the chart bar after bar and seek out possible trading setups. This is the grueling part, as you will have to sift through hundreds of them at a time to find the perfect setup.
o Step 3
Once you spot a possibly profitable setup, log all the information as pertains to your ‘virtual’ trade. An Excel spreadsheet is the best way to record the data. Note down starting date, entry point, reward-risk ratio, stop-loss, take-profit plus any other information you deem noteworthy. This will be used to analyze the strategy and gauge the success or failure of the same.
o Step 4
Step 4 isn’t necessary if you have found a working strategy. If not, however, get back on the chart and sift, once more, through the bars as you fine-tune your approach until you find a worthy setup. Then you can proceed to Step 3.
Manual backtesting is, from the onset, time-consuming. This is especially true since you will have to sift through piles of data unaided by any computer. Moreover, any proper backtest needs to go through as much data as possible.
Ten years’ worth of trading information is the go-to standard if you are looking to day trade your strategy. If you decide to go through such data, you ought to be mentally prepared for the workload. However, it is the most definitive way traders get to learn actual trading.
· Automated backtesting
Granted, manual backtesting takes time. Automated backtesting, on the other hand, uses computer programs to test out trading strategies. It is fast and traders can then evaluate a trading strategy faster than it would have taken using the manual method. Moreover, traders might have several approaches on tap and backtesting all of them manually just wouldn’t cut it.
Usually, to conduct an automated backtest, you first have to get a backtesting software. First, there are free versions that we shall consider in this article. Paid versions are also available and even demo accounts count as backtesting software.
Before getting on the testing platform, get some data from valid sources. Incorrect data invalidates your backtest, and you wouldn’t know exactly why. So go the extra mile with this one.
Backtesting on TradingView
TradingView is a web-based platform that allows you to not only create trading charts but conduct a backtest on your trading strategy. TradingView is an excellent back-tester because it comes at no cost to users. Moreover, the platform includes tens of tools and indicators you can include in your trading approach.
So how do you go about backtesting on TradingView?
o Step 1 – create an account on TradingView
Before you can begin testing strategies on the TradingView platform, you need to be logged in. It is a pretty straightforward procedure.
o Step 2 – Bar Replay
Once inside, head on to the Bar Replay option. This button is the main item when it comes to backtesting on TradingView. It allows you to access information for as far back as the server holds. The TradingView databank should quickly provide ten years’ worth of trading data.
o Step 3 – Adjust bar replay settings
Before running the replay command, make sure you have implemented all the indicators and tools you need on your strategy. TradingView is comprehensively equipped with indicators and other trading tools you would require to perform any trading approach. Add them and then roll back the date to when you would wish to commence backtesting.
o Step 4 – Start the bar replay
Simply engage the button with your cursor. Once it begins, you will be able to view each price across the years. You can, therefore, analyze the information and predict the price’s next move, after which you can engage the bar replay to see what is happening next.
Backtesting with TradingView Pros
- Free to use for TradingView users
- Easily accessible anywhere via a web-based platform
- You can conduct a manual backtest
- Accurate financial data
- Plenty of trading indicators are available
- A wealth of trading instruments, i.e., stocks, forex, crypto, ETFs etc.
Cons
- Lacks fundamental analysis
- Limited data for some assets
- Indicators with a security function in playback cannot be used
As mentioned before, backtesting plays an essential role in determining the success or failure of any trading strategy. If you are ready to put your plan to work, get it tested first and weed out any flaws in the approach.
Putting your strategy to work through a simulated trade allows you to optimize it and fine-tune your approach towards profitability. Also, when you see your plan successfully survive a backtest, expect a significant boost in your confidence before applying it onto real-time markets.
For newbie traders, backtesting provides an in-depth method through which they can gain much-needed experience in the trading scene.
In the case of manual backtesting, you will be required to sift through substantial data. Doing so exposes you to trades that occurred in the past. Through them, you can understand the world of trading to a greater degree, pick out patterns and price action throughout the timeframe selected.
So do not skip this essential part of trading, but rather embrace it. Remember, a well-thought-out and tested strategy is the key to earning a decent profit from the venture.