Do you trust your trading strategy?
If a trader does have trust in the method they intend on trading they will find it hard to stick to the system when hitting a period of drawdown.
If a belief is not established through the testing process – the trader may well be influenced to diverge from the system when going through a protracted drawdown.
Back-testing could help the trader become acquainted with the inescapable equity swings they will most likely meet and allows for fine tuning at an early stage of the system development life cycle.
What are the benefits of testing a system?
One benefit of manually testing a discretionary strategy is that, as referred to above, you will acquire a familiarity with the approach you mean to trade live.
Simulation testing can extend a good deal of useful statistical feedback related to a trading system and can be actioned on a mechanical or discretionary basis. There is validity in both approaches and the system you are intending to test will determine which method you utilise.
One benefit of manually testing a discretionary strategy is that, as mentioned above, you will gain a familiarity with the approach you intend on trading live.
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Please see this Forex strategy testing post for the entire article.
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The construct and initial principles of the system you intend on testing should be committed to paper before testing begins.
We will now look at a simple (example only) trading strategy to test:
• Test trade entry criteria. Inside day candle high is passed. Enter the trade if price has moved 10 points above the inside day.
• Test trade exit criteria. Exit when a 50 point trailing stop has been triggered.
• trade test hours between 07:00 – 13:00 GMT Monday – Wednesday.
The preceding simple rules could constitute the basis of testing.
Ensure you test the system on dissimilar market conditions including both ranging and trending periods.
Also test on several currency pairs as some strategies seem to test better than others on particular Forex currency pairs.
These are a few of the components I document when carrying out a manual testing session, in addition to the primary rules I specify as my trade entries and exits:
• What constituted the best exit from each trade? In other words how far did the trade ultimately go before reversing?
• Would this system bring better results, on a series of trades, with a bigger or smaller stop?
• How is the trading system affected if I remove periods of low liquidity i.e. no trading during US or European holiday periods?
• What was the maximum drawdown experienced?
• What was the biggest series of losses the system experienced?
• Does this trading strategy work well on some currency pairs and not on others?
• How did the method perform in ranging markets?
• How did the method perform in trending markets?
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