Day trading strategy testing
You will learn about the following concepts
- Backtesting a trading system
- Testing the strategy live on a demo account
- Keeping a trading journal
We’ve previously underscored many times the importance of having a solid trading strategy when your hard-earned money is at stake, one to which you must adhere during times of confusion or panic. However, in order to rely fully on your trading system to the point where you won’t question it after an unexpectedly long losing streak, it needs to be comprehensively tested and applied for a sufficient period so that fluctuations in its results are smoothed out. In this article, we will discuss the process of pre-testing, simulating and post-testing your trading strategy.
Backtesting a trading system
Obviously, the first step in incorporating a trading strategy is choosing one. There is no universal strategy, as each trader must select one that best suits their goals and risk profile, and then fine-tune it to achieve optimal performance. After a strategy has been chosen, its performance must be measured before real trading begins. The first step in testing is called backtesting.
- Trade Forex
- Trade Crypto
- Trade Stocks
- Regulation: NFA
- Leverage: Day Margin
- Min Deposit: $100
Backtesting is a method of evaluating a trading strategy by running it via special software through a database of historic securities prices to determine whether it would have achieved a return and whether that return would have been sufficient. The test includes variables such as position size, leverage and commissions, and yields results that inform you of win-loss ratios, returns, etc. You can then use this information to further tweak the trading strategy and run it again through the testing software.
The test itself requires several variables, starting with the asset and the buy pattern; you can then expand it by adding leverage and other data. Most backtesting software can help you optimise your trading strategy by suggesting position size, holding period and other parameters that will yield a better risk/reward ratio. Another useful aspect of these programmes is that they require precise instructions to be entered. However, if the trading strategy becomes too complicated to be tested by backtesting software, it is almost certainly too complicated for you to implement.
Testing the strategy live
Having chosen your trading strategy and successfully backtested it using specialised software, the next step is to try it out in live trading. Even though the tests might have achieved satisfactory results, you should initially refrain from committing real money. Instead, you can either monitor the market and record in a spreadsheet where you would have entered and exited, or, better yet, use a demo account.
Most reputable brokers give full access to demo accounts to test the service they provide. It wouldn’t be wise for a trader to deposit money with a brokerage firm whose technical performance they have not tested. Moreover, many brokers have proprietary trading platforms whose layouts may differ greatly; others use white-label products and customise them, further emphasising the need for testing. Although you might not be interested in platform assessment, you can use that opportunity to test your trading strategy for free. Demo accounts with most brokers can also be used indefinitely, allowing you to run extensive tests and obtain results stripped of volatility. If you want to learn more about why demo accounts are good for you, read the article “Advantages of Using a Demo Account“.
Trading logbook
As a trader begins testing a strategy on a demo account, they should put considerable effort into tracking their trades and building a detailed database of position entries and exits. Keeping such a logbook is best done using spreadsheet software, such as Microsoft Excel, Apache OpenOffice, etc. If you want to read more on trading journals, check out the article “Why are Trading Journals Important“.
There are many ways you can organise your journal, but the most basic form should include entry price, time of entry, position size, exit price, time of exit, total proceeds, commissions, and the gain/loss for the position. Another useful addition would be a calculation of your session’s net result after you exit the last trade.
Having estimated your daily performance, you can then make a profit and loss statement for the whole month. It should reflect the starting capital for each day, the net profit or loss in absolute terms and as a percentage, and the ending capital. You can then calculate your monthly income and, to be more comprehensive, break those numbers down into daily and hourly earnings.
Apart from the purely numerical data, you should also write down why you have entered a trade, why you have closed your position, and generally any other thoughts related to your trading session. This will help you better evaluate your decision-making at the end of the day.