subject: Back Testing for Metatrader [print this page] Back testing methods offered by a trading software help traders to review and rationalize their decisions while choosing their trading strategies.
What do people to do when they want to make profit in trading market?
An easy answer is that traders buy when prices are low and sell when it is high.
However, in order that such a profit making becomes a habit traders need to have answers for questions such as
What are the best stock/ currency/ commodity/ future/ index I must deal with?
When should I buy them?
When should I sell them?
Trading software answers these questions giving them access to traded prices over time besides allowing them to analyze on the price history. The markets have always shown a remarkable ability to bounce back from bottoms or retrace from the tops. A look at the prices over time reassures the trader that market corrections are a matter of time. They intuitively look for patterns to trade based on the repetitive nature of prices to reverse the rising and falling trends which they undergo while posting lows and highs.
Having said this we can easily recognize that traders instinctively look for repetitive patterns in the past price behaviour which they believe helps them to predict with certainty the future pattern of prices. These patterns could be based on indicators derived from the prices especially by their movements in a defined time period. Then they apply these indicators to get to understand whether sufficient numbers of successful/ profitable trades are possible to be executed to offset and exceed losses. It is possible that the successful trades to be a few but are capable of giving sufficient cash to overcome the losses in the large number of unsuccessful trades. In order to test this one needs to use a back testing facility in the trading software.
Advantages of back testing
Back testing helps traders to bridge the gap between their intuition, in arriving at future trends of prices to land in profitable trading mode which can also be called as their trading strategy, and the quantitative support from the historical price data for the stock/ currency/ commodity/ future/ index. Naturally back testing is method by which traders can validate the trading strategy.
Back testing therefore can be for the price patterns the underlying stock/ currency/ commodity/ future/ index had shown in the past. It can also be used on the future prices where such projections are made available for the trader by the trading system using the extending the recorded movements into coming periods.
Back testing helps formulate successful trading strategies without laying out cash to fund the testing period losses.
When back testing will fail?
Basic premise of trading is that past price patterns are a guide to predict the future trends of prices. In fact trading strategies are based on such assumptions and adopt suitable price indicators to measure the length of rising or falling trends over time and extent of movement. The assumption that a trader can successfully predict the future in itself is a refutation of that conjecture. The number people who have significantly built their wealth through short term trading can be counted. Again the statutory warning in each of the trading software models offered, a requirement imposed by National Futures Association, shows clearly as to past results of any trading system cannot be relied upon.
Back testing will fail when it is done on periods where prices movements are not representative of the entire history of trading. This can be avoided by visually looking at the price charts and identifying whether back testing period chosen is in itself a miniature of the larger data that price history had stored.
In order to be successful in using back testing and formulating trading strategy a trader must remember that human intuition can be rationalized to a limited extent with quantitative data to support the predicted behavior of prices. It is important to construct a set of indicators that not have worked in the past but will continue to work in the future. Finally the rewards from market always flow to few who have adopted contrarian view on market and change as soon as there are more followers of their strategy to deny them longer or larger profits from trades.
Back Testing for Metatrader
By: Eric Quentin
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