The Most Complete Backtest You Can Do

01/31/2012 11:00 am EST

Focus: TRADING

Jackie Ann Patterson

Author, Truth About ETF Rotation

The added detail required to backtest a trading strategy manually allows the trader to better simulate how they would fare with it under real market conditions, explains Jackie Ann Patterson.

As a trader or investor, you have probably heard about automated backtesting of a trading strategy, but what about manual backtesting?

Our guest today is Jackie Ann Patterson to talk about that. Well Jackie, first of all, can you manually backtest any strategy?

Certainly, yes; it involves a fair amount of detailed work, but you can go back and take the historical data and step through it.

It helps if you have a charting tool that will let you step bar by bar so you can’t look ahead—no peeking—but you look at what the price action is doing and look at your other metrics or data (if you have any fundamental data) and then make a decision like you would if you were really trading and keep track of that. 

I use a spreadsheet; you could just write it on paper. Then you click forward and move to the next bar and evaluate the trading strategy that way. 

So that is what you have to do if you are going to do manual backtesting.

Well thank goodness we have computers, so hopefully we don’t have to go through all of those steps if we don’t want to, but when I get the data back, how do I read it in a way that makes sense to me if I’m not a computer programmer?

I think there are a couple of things. Something that might be gained from manual backtesting is being able to see a little bit of how it feels. Of course, it is not a live trade, so not all the pressure of making money is there, but you can still get some idea. 
For example, a strategy for selling short will lose money when the market goes up, and you can see that in the numbers if you are reading the backtesting report or if you have done that manual backtesting yourself.

But it is important to sit and really think about that and try and get a sense of how does this feel? Am I going to be okay with that really?

You know it’s not just a number on a piece of paper when you are looking at these results. You have got to try and get some meaning into it and try and understand how it is going to affect you as a trader. 

More and more these days we have high-frequency trading and more and more of the volume seems to be automated trading these days.

Can I compete with the Ph.Ds from MIT that are writing these algorithms as an at-home trader with TradeStation or another one of the programs?

You know, I think that the opportunities are still there.

I wouldn’t necessarily go head-to-head in the high-frequency trading, especially not from home because they are co-locating, they are getting every advantage, but I think some of the time-tested methods with the stock market—particularly longer term—some of that isn’t going to change. The human behavior isn’t going to change.

So even though there is more short-term volatility and more movements there—and perhaps we need to take that into consideration and be willing to stomach some of that more—I still think the age-old trend following is going to apply, that we are still going to get price trends, partly because it is driven by how we think as humans.

Even the programs are written by human beings.

Yes, exactly. 

Related Reading:

Related Articles on TRADING