The Pitfall of Back Testing

Peter Lee
http://www.peterlee.id.au

How does one go about back testing a trading system? In my opinion, there are two ways - by using a computer and by hand. The most popular way is to use a computer program such as Wealth-Lab and it is easy to see why: it is fast, efficient, and can generate all kinds of statistical information.

However, the main draw back of relying purely on a computer program when system testing is that when the time comes to put your money on the line, you will most likely find it very hard to pull the trigger. This happens a lot and I believe the main cause is due to the absence of working through the trades individually, one by one.

Before the widespread usage of computerized testing most people did it by hand. The process is often long and tedious but it results in the person having the confidence to execute the trade.

There are many advantages of going through each trade individually, with the most important one being that you will experience the ups and downs of the system, trade by trade. You get to see and feel how each trade pans out instead of glossing over the results that the program prints out. This process builds confidence.

The best way to go about solving this problem is to go through the trades of a bullish year and a bearish year, bar by bar. This will subject you to the performance of the system as it goes through its wins and losses in two different types of markets. If you come out after going through the process you will at the very least gain a better understanding of the interaction of the system with your own psychological make up.

If you want to get the best results out of your back testing and trading, it is vital that you go through the process mentioned in this article. It should not take you too long to go through the process and the results may just surprise you!