Why Back Testing is Important in Trading

Most traders know the value of implementing trading systems but not all of them recognize the importance of back testing. If you’ve only just begun dabbling in market investments, this is one of the many considerations that you should focus on right away. You just can’t make considerable profits without it.

For beginners, the term doesn’t immediately give itself away. Even so, it is not a very complicated term to understand. What it involves is taking a trade system or plan into a process that will run it through a set of historical market data. This will let you see how a certain system will fare against a set of past market information.

The most obvious advantage of getting into comprehensive back tests is obvious. Clearly the procedure gives traders a chance to determine if their current approach is likely to be successful or not. In other words, they get an insight on whether the plans they are thinking of adopting have the potential to be profitable. Even if you are only dealing with historical details, you will still be able to arrive at the answer to the question of profitability simply because what has happened in the past can replicate itself in a similar fashion in the future.

There’s more than just a single shot at profitability at stake here. A truly scientific test can also help determine if a system can consistently perform well in future trades. Moreover, it can also help supply the necessary information that you would need to improve or complete your plan. A test for example can help you decide on how and where to allocate your resources.

The technical benefits of back testing are clear. Bear in mind though that there are also intangible benefits that you can gain from it. The most important advantage of the process is that it solidifies a trader’s confidence in his system. Being confident is crucial because without this feeling, you will forever be tempted to abandon or arbitrarily and constantly modify your plan even if it might potentially yield some profitable and sustainable results. In effect, you will be trading as if you had no clear plan at all.

In short, a systematic and comprehensive test has a lasting impact on trading psychology. Once you’ve finished pushing your plan through a series of back tests, you will cease to be afraid of your decisions. Because you know that your plan works, you never have to hold on too long or let go too early of your trade positions.

You can test your chosen system using the software included in your charting package. In some cases though, these testers just aren’t good enough. A typically ineffective tool takes a system through securities individually. This doesn’t just render slow results. It also leads to inaccurate conclusions simply because securities aren’t treated as part of a portfolio. An ideal procedure should be able to take into account the interrelatedness of a portfolio of securities.

You can’t go wrong with back testing. This is the one key that can most likely lead to profitable results. Don’t just settle for any test facility though. Go for one that has been proven to be effective and reliable.

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