The Power of Backtesting Analysis

Backtesting is one a vital function of developing an effective trading system. The process itself can be completed by taking historical data and reconstructing trades from the past that used rules of a strategy that you may be contemplating yourself. By comparing the statistics that you gleam while building past hypotheticals you can determine how effective the strategy would be if utilizing it now as well as discover ways to fine tune strategies and pinpoint flaws in a strategy before actually placing any solid investments or trades down with the said strategy.

Obviously, the theory behind backtesting is that if it would have worked in the past against data and trading scenarios than it will continue to work in the future as well as the vice versa that if the strategy fails to measure up in the past it will fail if attempted in the future. There are many different strategies that can be used when it comes to backtesting and many different results that can be obtained if you correctly learn what data to interpret and what needs to be gleamed from the data that is compiled. The following are just a few tips that can help you backtest and choose an effective trading strategy.

The first thing that you need to be familiar with before you can use backtesting to help improve your technical stock trading techniques, are the universal statistics behind backtesting that can be utilized and turned into feedback. Among the most important is the time frame of the testing, the stocks that are part of the backtest which are commonly referred to as the universe, and the net profit or loss which of course is the net percentage of loss or gain. This last part is the true definition of how effective the strategy will be in the long term if you choose to model your investments after it.

Also included in the statistics of backtesting are ratios, annualized returns, exposure, averages, and volatility measures. After you have these under your belt, it is important to define what types of trading systems can be used when it comes to backtesting. The truth is that any trading system that can be quantified can be used, since the mathematics will never change. On the other hand, systems that include qualitative judgments based on human decision making cannot be used since the results will potentially change each time.

It is also important to understand that a backtest cannot be completed in just five minutes, at least not if you want true results. This is due to the fact that in order to get the best results you will need to compile extensive details and data. However, if a major investment is being considered, taking the time out to perform a thorough back test can be well worth it since the results of your back test can determine if you are making the correct decision or not.

This is the reason why backtesting is often considered the backbone of developing an effective trading system that will show results. If you do not have the time to perform your own backtesting, you may want to look at financial services sites such as Market In&Out Stock Screener that already have tested trading strategies so that you can find the best backtested investment strategies.