Testing trading plans

Testing trading plans

SHARE

In previous article we introduced trading plans, but in this we’ll show you how to test them.

Once you’ve created your trading plan and went through all the necessary steps outlined in this article, you will need to test it in order to qualify it as a profitable plan. The process of testing trading plans is a crucial aspect of trading, because it allows you to have a closer to reality expectation of your work.

Be warned, the testing of your trade plan is based on past information and future projections, it is speculative information and should be treated as such. Regardless of this speculative nature, testing your plans improves the likelihood that they will work and bring you profit. The tools that you can take to determine whether a plan is going to be successful in the future are called Backtesting and Forward Performance Testing

Backtesting

This tool simply puts your trading plan to use and evaluates how it would have performed in a specified time period, based on historical data. While most traditional platforms support this feature, not all of the cryptocurrency exchanges do. One of the best resources for this kind of information is this great online tool called Tradewave. It allows you to create and test trading plans for free. Backtesting allows you to evaluate different trading ideas, such as moving average crossover or even more complicated trading plan such as the Bollinger Band Mean Reversion strategy. (We are not affiliated with Tradewave in anyway, we are simply sharing this amazing and free tool with you).

Some people prefer to cooperate with programmers that are able to transform an idea into an testable and executable form. These programmers use the proprietary computer language used by the trade platforms, integrating your trading plan inputs into the backtesting. The process of optimizing a system to create a high percentage of winning against historical data is called curve fitting, and it can cause amazing results, but please note that you could generate 100% winning scenarios using this tool, with the results being completely unrealistic. This is because backtesting allows the possibility of tweaking in a situation with perfect information (where everything is known), while live trading is not such a scenario, but rather represents a situation with imperfect information.

The implications that your backtesting results can show up falsely positive profits is not to be intimidated by, because once you generate a profitable, backtested trading plan, the next course of action is to virtually test it against real-time market data.

Sampling data

When testing it is important to reserve a time period exclusively for testing, called in-sample. This period will serve as the bouncing board for your system and after you manage to create a profitable system on it, you will proceed to test it onto other time periods to see how it would have performed in a different setting. This will challenge the system and expose any flaws, with the addition of giving you a better image of the results your system would produce in a live trading session.

Before you start backtesting and optimizing, you can reserve data for the out-sample testing. This is the time period that you will test on after you’ve optimized your system. One of the methods to easily select historical data is to separate it into three equal parts and use two of them for the in-sample (the part of developing and optimizing the trading plan) and one of them for the out-sample.

After the trading plan has been evaluated and optimized using the selected in-sample you can apply it to the out-sample. If the results are significantly different, it is most likely that your system is not going to perform good in live trading, in other words it is over-optimized. On the other hand, if it strongly resembles the in-sample data, the next step of evaluation is the forward performance testing method.

Forward Performance Testing

This tool represents a simulation of real life trading and it follows the systems logic in real markets. The trades made by this tool are simply documented without any transactions, but the results that the trading plan would have produced are being transcribed and calculated. A lot of exchanges are offering this type on the traditional markets, but it’s rarely seen on cryptocurrency’s markets.

We are on the lookout for any news and there are some sites promising to develop such simulated environments for cryptomarkets, but nothing really worth sharing right now. Do not worry though, we promise to inform you as soon as some smart developer creates a platform that allows this kind of testing for cryptocurrencies.

Live Trading Performance

Minimizing the risk of trading is the main goal, that is achieved by testing your trading plans. This leads to consistency and generates higher profits. The evaluation of a trading plan doesn’t end in simulated or backtested scenarios, but it is very important that it continues even after its successful integration on trading platforms. Evaluating live performance allows us to determine how efficient our trading plan is in reality.

Equity curves can help you determine how much correlation exists between real trading results and testing results. It shows profit and loss over a specified period of time. The overall trend of the equity curve should be upward, with fluctuation being a normal part of the curve, although upward dominance should be clearly seen. If your testing results show an ideal equity curve, but live trading results show the opposite, then they are not correlated. Conversely if they are the same, then you’re on the correct path to profit. If live trading results, start to differentiate from testing results, then it is time to revise the plan. This usually involves making changes to factors, resulting with lower performance on the historical results, while increasing the realistic opportunity for live markets.

Trading experience is the ultimate tool in the trader’s belt, since sometimes even the systems that have consistently shown great amounts of correlation between testing results, have failed on the live markets. Through this trading experience, it’s less of a challenge to figure out what went wrong and fix the underlying causes of loss.
To conclude this series of trading introduction we will review what we’ve learned so far. We figured out that as a trader, you are basically your own employer, so it is your own duty to manage your motivation and schedule, from the comfort of your own home. It is easy to get into trading, but rather difficult to become a successful trader. It is like any competitive sports game, basketball, video games, baseball, football, rather it is easy to start and play around, but to become a competitive trader, capable of understanding and effectively beating the market and claiming their own profit is a completely different story. You could make it, but only if you are willing to invest the time and effort to learn the skills necessary to be effective, profitable, and become a pro trader.

This short three article series is meant as an introduction to trading, and it’s by no means the one and only source of information you need to use. But it’s a great starting point. Follow us on www.crypto-news.net for more updates on cryptomarket related news and trading techniques, as we will produce more and more quality content for you the reader and hopefully successful trader to benefit from. Remember, trading is not a hobby, it is a business in the purest of forms. A long-term engagement that requires adaptation, expectation, evaluation and constant restless learning. When engaged in this way, trading can be an exhilarating and profitable adventure for you!

NO COMMENTS