The strength of any business or trade is a viable strategy, it involves all the smart works that ease the process of trading and business interaction.
Moreover, the aim of any commercial activity is to make profit.
Most businesses stand a high risk of loss when they have weak business strategies. There are arrays of tools, mediums, and methods vital to building a trading strategy with back testing forming a key basis.
Back testing is a trading strategy that helps to stimulate a trading strategy by employing historical data to analyze risks and generate results.
A formidable back test confirms the profitability and durability of a strategy when implemented in reality. It is particularly useful for complex trading strategies such as trading strategies for automated trading systems.
Back testing is like training or simulation in a field to accelerate performance and efficiency. It requires simulating previous conditions to prove the worth of a business.
Back testing is required mostly by traders and investors who rely on qualified programmers to develop trading strategies and ideas into a testable form with coding languages hosted by the targeted trading platform.
Back testing provides several valuable information about a system. To run effective back testing, you need these basic tools:
● Quality historical data.
● Simulation software package.
● A well-defined strategy.
● An extensive back testing analysis.
Nonetheless, there are key factors that set the standard for ideal back testing which include:
● Historical data: Historical data must include stock samples of bankrupt or liquidated companies as well as data from existing historical stocks. When using historical data, it is also significant to consider the universe or niche in which the back testing occurs.
● Viability: back testing evaluates the feasibility of a pricing model or trading strategy by researching its results through historical data.
● Trading cost: all trading costs must be assessed irrespective of its significance as it can take a huge toll on the profitability of a strategy.
● Volatility: it is very important to test for volatility measures as it helps in developing a trading system, reduces risks and eases transaction in and out of given stock.
● Bars: the average number of bars available is also very vital when back testing and developing a trading system
● Exposure: exposure is dicey, while increased exposure can mean higher profits, it can also mean higher loss. Decreased exposure can mean either lower loss or lower profit.
It is best to keep exposure below 70% to reduce unpredicted risks.
Without a doubt, back testing has various benefits as it helps to:
● Discover trading strategy problems that are impossible to uncover by simple strategy description.
● It also allows investors and traders to determine unfavorable conditions that can result in unprofitable ventures.
● It gives feasible assessments of available skills and capabilities to execute trading strategies.
● The real-world stats it provides will give realistic expectations on profitability, risks and required capital. If a back test generates a positive result then it accelerated steps in cementing the trading strategy.
While back testing has proven effective in establishing a viable trading strategy, the strategy like other modelling has its limitations which include market pattern changes that are usually unpredictable as volatility changes for a specific market or the whole market.
Moreover, the back testing done on a demo account does not always match with the data available for real accounts.
In sum, back testing provides a fundamental ground for analyzing and evaluating business strategies and trading success, giving investors and traders the confidence to embark on profitable businesses.