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Back Testing Software – What Is It?
By plrprousers | January 17, 2010
Create a Profitable Trading System
Back testing software is an integral cog in the process of analysing trading systems. Back testing is the process of testing a trading strategy using historical data rather than testing it in real time with real money. The metrics obtained from testing via back testing software can be used as an indication of how well the strategy would have performed had it been applied to past trades. Interpreting these results then provides the trader with sufficient metrics to assess the potential of the trading system.
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.
But the question remains: how can you test a trading system’s performance over time? There are only two ways to do this – manually or with computer software. To be honest, computer software is the only ‘real’ option. I have done both testing methods and manual testing is not only time consuming but very hard to replicate and test effectively.
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
Back testing will work well if your mechanical trading system is able to work with price date.
Here is an example of a rule that you might want to use with your mechanical system:
Purchase the security when the ten day moving average that is grouped with the closing price goes pas the thirty day average.
This rule can be tested quite easily over historical data. On the other hand, if your buy signal rule was a little more complex such as:
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 problem is that the majority of mechanical trading systems using fundamental data are far beyond the scope of retail investors simply because there is a major lack of historical date which can be used to completely do the back test.
Back testing software
Most chartering packages right now have their own back testing tools built in. If you followed the steps in the last chapter, then you should have no trouble choosing a decent charting package. Having followed it completely, you have more than likely either found a package that includes the software, or can at least interface with a good piece of back testing software.
TradeSim is probably the most realistic, true trading simulator/analyser I have found. It can quickly back test and evaluate a trading system, whether a single security or a multiple-security portfolio.
I believe back testing is the only way to remove self-doubt. Once you have established that you have a reliable and robust trading system only then will you be confident in trading it.
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.
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