Backtesting
Candlefocus EditorBacktesting involves running a trading strategy over historical price data points, evaluating the resulting outcomes and analyzing the performance of the strategy. It is a form of paper trading where simulated trades are executed based on a preset strategy and the outcome is monitored. By simulating the strategy using historical data, it is possible to determine whether it is profitable under different market conditions. It is also possible to identify areas where the strategy might need improvement or further testing.
The process of backtesting involves the following steps:
1. Set up a trading system that includes entry, exit and risk management criteria.
2. Define the maximum desired ranges for parameters such as drawdown, profit/loss ratio and win rate.
3. Set up a portfolio managed by the tested system.
4. Run backtests on historic data to find likely parameter settings (i.e. stop loss and take-profit).
5. Test the portfolio’s past performance with different parameter settings.
6. Evaluate the performance of the portfolio based on metrics such as risk-adjusted returns, win rate and maximum drawdown.
7. Optimize the system and adjust the parameter settings to achieve better performance.
8. Evaluate the stability and the profitability of the backtested portfolio under different market conditions.
Backtesting can be time-consuming and labor-intensive, but it is critical for developing reliable trading strategies. Backtesting requires an understanding of the relevant markets, market conditions and strategy development fundamentals. It should also be conducted with a proven risk-management framework in place. Backtesting can produce valuable insights into the performance of a strategy and help traders make more informed decisions.