Benefits of Backtesting: Backtesting is a key factor that helps to develop an effective trading system. It refers to testing your trading strategy on historical data and checking how it performs previously.
Back-testing your trading strategy helps you to identify whether your trading strategy works or not in the market without investing real money. If it works means you can use it for actual trading.
If you think that, backtesting takes too much time, it helps you to trade with more confidence with your trading plan.
While you start backtesting, you will get an idea about the right entry, exit, and stop-loss so that when you begin actual trading with the back-tested strategy you can trade easily with more confidence.
Benefits of Backtesting:
- No Risk of Loss
Backtesting is an estimation of the output of trading strategies it helps traders to test every different trading strategy very easily without any risk as there is no requirement for capital. It also helps to learn more about the performance of the strategy in different market trends.
- Helps to improve strategy
With frequent backtesting, traders can change the strategy or accept or reject the strategies based on the output derived from the backtesting.
- Trading Direction
The results from backtesting help traders make important decisions about which stock to trade when to enter or exit. It can be helpful for traders to select a few trading strategies they can use for the best result. Also with backtesting traders can get an idea of what the right time to use strategy is.
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- Help traders understand the market
Researching and back-testing the trading strategies and trends can help traders to better understand the market. This can be a learning opportunity for new traders also, as it helps them to check the result of their strategies.
So these are the benefits of backtesting. Now let’s go through the step-by-step guide to the back-test trading strategy.
How to Backtest strategy?
You can do backtest strategy with two methods. One is manual and the other is automated backtesting which can be done with the help of different charting platforms and software.
Method 1: How to back-test manually? It involves following steps.
• Very first step is to have a clearly defined and in-depth trading strategy. When you don’t have a clear in-depth strategy it would be waste of time. So first have a detailed trading plan with clarity.
• Once you are done with the first step, now the next step is to select the segment in which you want to do backtesting. Either you want to go with the equity segment or for Index and then according to the segment select the time frame.
• As you are ready with all the setup, now you can go back to historical charts and find out buy or sell signals according to your strategy and note down entry, exit and stop–loss. Also, find out how many times your strategy works and for how much time stop-loss hits.
• Manual method will take time, but it can be helpful to gain confidence with your trading setup.
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Method 2: Backtest with trading software
• You can do an automated backtest with different software like AmiBroker, MT4, etc.
• Here also, You need a clear trading strategy. Now select the segment and time frame.
• Now different software, they have its own coding language so you need to write your strategy in the form of code and select the run backtesting.
• The software will automatically do the backtest and give the result within a few minutes.
• Disadvantage of this method is you have to get knowledge about coding language to back taste your trading strategy automatically.
• So it is better to do it manually.
Backtesting is a very helpful part of trading as it provides results of trading strategies without investing real money. You can take the right decision whether to use strategy or move to the next one.