What is Backtesting ?
Backtesting is a process offered by software that allows traders to test a theoretical trading system or strategy prior to employing their strategy in real time. Backtesting is based on past data, that is, your strategy is tested on past prices of a company share or CFD.
For instance if you are backtesting your strategy you will be testing your strategy on the price history available from your CFD provider. Some providers offer the entire price history and some providers only go back a certain number of years check facts.
Prior to backtesting you should make a note of your system or strategy, how it is meant to work, what tools and indicators you’d like to use, and so on. This is so you make sure you are clear on what data you ask the software to test against.
A proper system should specify a budget, trade sizes, where to set your stop losses, enter and exit points, and indicators to use such as moving averages, RSI, TSI, MACD, etc. Strategies should be reviewed often enough to be able to adapt to market conditions. For example, you might have to modify a strategy you used during a bull market to adapt to an economy recovering from a recession. Overall, what you are looking for is a good and consistent win/loss ratio.
There are a number of software programs that allow traders to do backtesting. Some CFD providers alsoprovide built third party backtesting software, such as Capital CFDs. Some backtesting providers charge a premium for their services and others, like IQBroker are free.
How to Perform a Backtest?
Backtesting is a simple procedure. If you want to see how it works, watch an online tutorial or start by watching a sample at http://timetotrade.eu/simulated_trading.php.
It is also advisable to check out a range of backtesting software providers like Metastock, TradeSim, AmiBroker, TradeStation and WealthLab.
It is exciting to backtest your strategy and see it in action but be careful. Have in mind that when backtesting the software will not only calculate winning trades, it will also give you losing trades. It is also important to look out for glitches or bugs in the software, as they could occur at any time.
Remember that it is a test based on past data and that past results doesn’t mean future results. However, backtesting can give a trader more confidence and better chances at improving their trading results.