I have lost count of the number of times I have suggested to Safety in the Market students that “backtesting will confirm that”, “the only way to find out is to backtest”, “get to know your market by backtesting” and similar comments.
Recently a student suggested that we run a course just on backtesting. Whilst we try to include it at the Interactive Trading Workshop we have so much material to cover that it invariable is left to a very simple overview. And as my last article on backtesting received many enquiries (Patience is Not Just a Card Game) I thought I would put forward some more suggestions in this article.
Now there is no rigid process to backtesting a market, and it is very much up to individuals to apply their own discipline and decide to what level of detail they want to go. I might also suggest though that the effort someone puts in to backtesting might also correspond to the results achieved in his or her trading.
So how should we begin? Let’s start with the Smarter Starter Pack ABC trades. In ProfitSource bring up the chart of your chosen market and put on the ABC Hilites. Right click on the label in the top left and select Copy as shown in Chart 1.
Chart 1: Copy ABC Hilites
click to enlarge
We can then paste the list of trades into excel and start to analyse each ABC trade. For every trade taken you will then apply each of the stop management strategies you have learned, noting down the profit or loss. I have mocked up and example for you in Chart 2. If you find the prospect of this overwhelming, at least work through the trades during select periods, i.e. a bear market, a bull market and a sideways market. At the end of this process you will begin to have a picture of which stop management works best on your market.
Chart 2: Excel Spreadsheet for Backtesting
click to enlarge
As well as 1-day ABCs we would look at multi-day and weekly ABCs using the same process, but ABC setups aren’t the only thing we can backtest. One trader recently was frustrated with being stopped out at C+/-1 only to see the market turn around and race to 100% of his trade. He decided to backtest false breaks on his market. He tested every single ABC trade, and worked out by how much Point C was broken when it was a false break, and how much indicated a genuine change in trend. This gave him a figure of how far above or behind Point C to place his stops. The immediate result was that his next 2 trades where his most profitable ones to date and they would both have been stopped out at C+/-1.
In my article Left Stranded by an Island Reversal, I backtested island reversal signals by looking back through the history of CBA for that particular chart pattern.
It is really up to the individual how much backtesting you wish to do, but the whole principle we teach at Safety in the Market is that “History Repeats”, and by backtesting we are beginning to understand what happened in history so that we can trade it in the future. As we keep saying, “ let your hindsight become your foresight”.
It’s the journey