Back Testing Software – What Is It?
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.
Logically, we know that the results from this type of testing will not be able to predict future returns with pinpoint accuracy; however, it can provide an indicator as to whether you should even pursue a trading system or not. What’s more, if you decide to go ahead and trade the system, it will give you guides on what to expect.
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.
Back testing software can be quite beneficial to you. It will let you test your system, and overall it’s going to save you a lot more money, covering your initial investment in the back testing process. If you want your trading system to be a success, you will consider investing in this.
Mechanical Back Testing
Keep in mind that if your mechanical trading system works exclusively with price data, back testing software will be a viable option.
For example, say you create a mechanical trading system with the following entry rule:
Purchase the security when the ten day moving average that is grouped with the closing price goes pas the thirty day average.
By utilizing this particular rule using historical date, you will find that the back testing is pretty easy. Signal rules on the other hand are a bit harder:
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.
This rule introduces data that is not often supplied or maintained in a database of price information. To successfully back test this would involve obtaining historical data of a security as well as the price-to-earnings ratio (PE ratio). Typically, historical data on a group of equities would only include the open, high, low, close and volume for each period. Because of this limitation, many mechanical trading systems are designed around purely price technical indicators.
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
As luck would have it, the majority of chartering packages these days have back testing software included. In the chapter preceding this one, there was a process for choosing a good chartering package, and so long as you followed it to the letter, you likely found one that either has it’s own back testing features, or at least one that is compatible with other back testing software.
If you’re looking for a decent piece of software, you should definitely have a look at TradeSim. It can help you back test and check out a trading system with relative ease. Regardless of whether or not you’re dealing with a single security, or an entire 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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