Importance of Recording Historical Trades: Backtesting Strategies and Having a Valid Trading Plan
Ever wondered, “What is the secret of trading?” or “What gives you an edge in trading?” It’s all embedded in this article. Keep reading while we unravel these secrets!
It is popularly said that people who do not grasp history are bound to repeat it. Hence, the study of historical data analysis seeks to not only avoid previous mistakes but also gain a competitive advantage in the future.
The study of market behavior over a specific period is known as historical data analysis. The term “market behavior” refers to the many aspects of the market and its interactions. Market-related data such as price, volatility, and volume may be quantified and evaluated over time.
Historical data analysis for a certain investment or market may be valuable in numerous ways.
System development: A statistical “edge” can be found and built for active trading using historical data analysis. The establishment of a trading system begins with a clear description of when what, and how to trade a certain market, and this helps in system development.
Market insight: An extensive examination of a financial instrument’s or market’s prior behavior can give a trader an understanding of the traits demonstrated by the usual and exceptional trades.
Consistency: Choosing deals with a predetermined conclusion based on historical data analysis might offer the trader confidence in the prospective outcome. Also, unwanted outcomes can be reduced by analyzing how a certain deal has fared over time.
Backtesting as a Trading Strategy
Backtesting is the process of evaluating a trading strategy based on historical data to determine its accuracy without actually investing.
Backtesting is performed by recreating transactions that would have occurred in the past if a set of rules had been followed. These rules are set by a specific strategy utilizing historical data. The outcome of this strategy provides statistics to assess the efficacy of the strategy.
When traders quantify risk and reward as the basis of their strategy, they have higher chances of trading effectively. Backtesting is all about analyzing the past and forecasting the future behavior of a trading strategy.
Instead of providing fast, random advice (which may be regrettable), backtesting supports a tried and true strategy.
The theory of backtesting is that a trading strategy that performed satisfactorily in the past is most likely to perform satisfactorily in the long term, and any strategy that has performed poorly in the past is most likely to perform poorly in the future.
My trading strategy isn’t going well; is something wrong?
“I have a trading plan, but my trade is not going well.” There are two possibilities: something in the strategy is not serving, or you are not keeping to the plan.
If you want to become an efficient trader, you must have a strategy. Never underestimate the importance of planning. If you stick to the plan, with time, you can go back and perform additional testing.
If the strategy is sound and has been backtested and paper traded (or forward-tested with only a small amount of money), the problem is most likely that you are not following it.
Rather than abandoning your trading strategy entirely, you may make tweaks and fine-tune it until you reach the desired results.
If the backtest yields poor results, traders must either optimize or disapprove of the strategy. Properly executed backtesting with positive results increases the trader’s drive and motivation to move forward with the strategy. The essence of backtesting cannot be overemphasized!
How Do I Conduct A Backtest?
Backtesting is a trading strategy that can be done in two ways. These include:
Manual backtesting is a method through which traders study trading techniques using historical data and assess the findings on their own.
Automated back-testing is a method through which software performs a back-test automatically. This means that no additional manual efforts are required.
For modern traders, automation has simplified the process and dramatically increased efficiency. Trading platforms offer software capabilities for carrying out in-depth strategy backtesting operations.
How important is a trading strategy?
Although all effective trading material emphasizes the need for developing a trading plan, most people do not construct one. Most traders are already aware of this, but making a strategy appears to be a lot of effort (and it is), which is probably one of the main reasons why people don’t bother.
No trader will achieve long-term success in the market unless they have a precise and clearly defined trading strategy that they stick to because it’s one thing to have the strategy, and it’s another to implement it.
New traders sometimes enter the market without a strategy and, as a result, have little concern for their risk and profit objectives. All they are concerned about is “I want to earn money.” Fantastic! But this is not a strategy, but a wish!
Unfortunately, far too many people nowadays come to trading under the misguided impression that they will be able to make it through without a trading strategy.
A trader without a strategy is more likely to rely on instincts, guesswork, suggestions, and even happenstance. For these traders, the experience is typically a nail-biting, bumpy road that results in a devastating trading journey.
Just as no one in their right mind would start (or maintain) a firm without a clear business strategy, In the same way, no serious trader should begin (or continue) trading without a comprehensive trading plan.
Also, a trading strategy will help you to eliminate emotional breakdowns so that when market conditions force you to make decisions on the fly, you have a playbook on how to deal with the issue or have it all written down or coded into your trading software, and it takes care of itself.
Finally, a trading strategy is intended to allow the calm, analytical you to overrule the emotional, irrational you.
How will backtesting give me an edge in trading?
Many skilled and competent traders are great record keepers. If they win a transaction, they want to know why and how they won.
More importantly, when they lose, people want to know what happened so they don’t make the same mistakes again.
Details such as goals, the entrance and exit of each trade, the time, support and resistance levels, the daily opening range, market open and close for the day, and remarks about why you made the trade, as well as the lessons learned, should be recorded.
After the testing is finished, performance measurements may be applied to the findings and used to judge the strategy’s feasibility.
A thorough backtest is used to quantify several important statistics, including:
Several opportunities: An important piece of information is the size and frequency of trade setups generated by a strategy over a certain time frame.
Success rate: The win-loss percentage or likelihood of success of a strategy may be used to assess if it is an effective trading method for a specific market.
Risk versus gain: It can also provide some insight into when and what to engage with best. The necessary capital to effectively execute a trading approach on a market or product can be determined by a backtesting study.
Additionally, you should keep track of your trades so that you may review them later and assess the profit or loss for a certain trading system, drawdowns (amounts lost per trade using a trading system), average transaction time (needed to determine trade efficiency), and other crucial elements.
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Keep in mind that, as a trader, you are the accountant in your firm. You want your company to be as prosperous as it can be. Hence, have a valid trading plan and stick to it! We hope you enjoyed this piece. We look forward to hearing from you in the comment section below. Thank you!!