Backtesting: advantages and disadvantages of the system
Backtesting is one of the necessary tools to create a trading strategy, which will bring high profits. It allows you to monitor system performance by analyzing past trading patterns. Backtesting is the compilation of a trading process based on the principles and actions used in previous operations.
Through backtesting, you can obtain statistics that show the profitability of market activities. By analyzing this information, a trader is able to improve the effectiveness of the adopted strategy, identify its shortcomings in advance and correct them.
The use of backtesting is based on one principle, which means that if the trading system has worked in the past, it will show good results in future use.
Backtest provides important information that will allow a trader to close trades successfully. It shows the ratio between the number of profitable and loss-making trades and compares the overall performance in both cases. With the help of the tool, you can identify the most optimal period of time when trading is best. The backtest analyzes assets to see which ones will be the most successful. The trader receives the account volatility history, which is compiled on the basis of profit and loss peaks, and also provides data on the average value of one or another variant of a trade.
Backtesting provides information about the period during which positions are at a certain level. The tool shows a graph of a trading strategy’s profitability for the year and calculates its performance, taking into account the risks and their variability.
When working with backtesting, you need special software that can be conveniently used on two monitors. One screen is used to set up the analysis parameters, while the other provides the result. To use this system, you need to enter a number of parameters into the program:
- commission rate;
- transaction volume;
- cost of each point;
- interest rate value.
In addition, you should mark the main points for setting a trailing stop, enter the values of restrictive orders and other factors. The accuracy of the analysis depends on the accuracy of the entered parameters.
Re-optimization is a common situation in the backtest process. It happens if the strategy’s indicators are adjusted to the values observed in previous trade operations. In this variant, the system will show good results in previous cases, but will not bring profit in the current use. To exclude this fact, it is necessary to apply backtesting for a large period of time, where different trends were observed and market conditions were changing.
It should also be taken into account that backtesting conducted for shares of technological companies will be useless for securities of other sectors. Besides, the trading results should be evaluated from the point of view of volatility.