How Backtesting Can Change Your Entire Trading Strategy

While backtesting often gets ignored by beginner traders, it’s a very viable approach that can produce unexpected results when applied correctly. Of course, it’s not a magic wand that can automatically solve all problems you’re having in your current trading situation, but it can significantly improve your chances for the future. This is especially true if you’ve made some mistakes in the past – those are great learning opportunities that can shed a lot of light on what you’re doing wrong, and give you ideas on correcting your approach. As with any other technique though, backtesting has to be utilized correctly to produce the right results. Let’s have a look at how it can help you and what you need to know in order to harness its full potential.

Minimize the Impact of Random Variations

Randomness is everywhere in the trading market, and there’s no way to circumvent that. This will continue to be the case in the future as well, and it’s not reasonable to expect that the market will just drift towards a stable state. If anything, you should fully expect things to become even more chaotic as new trends set in, and new technologies are introduced.

With a good backtesting approach, you can learn a lot from those random deviations however. In fact, sometimes you might discover that processes which appear random at a glance are actually subject to a lot of control – but you were simply never aware of the actual forces behind them until now. Of course, you need to couple your approach with strong analytical capabilities in order to see those connections and figure out where you’re going wrong.

Understand Your Key Metrics

A common problem in trading which can often lead to lots of issues down the road is a lack of understanding of the key metrics that drive your decisions. Even worse, you might sometimes assume that you do understand those metrics, when you’re simply working with inaccurate data from the get go. Using the best backtesting software can give you a good opportunity to reevaluate past developments and look at them from a new perspective, which can give you a significantly better understanding of the way you should be looking at the data you’re working with. In some cases you’ll even discover completely new data points which you may have been ignoring until then, further driving up your potential for success!

Simplify Your Approach

Are you wasting effort and/or resources? It’s hard to tell without taking a retrospective look at your past trades. This is one of the most powerful aspects of backtesting, and a good reason to apply it to your trading by itself. You can trim a lot of the fat by simply gaining a deeper understanding of the way you’re navigating the market, and you’ll be able to make more informed decisions with less available information in the long run. Backtesting can also teach you how to get to a desired result faster, although this will vary according to your exact operations, and might take a few iterations before you start to see proper results.

Develop a Simple, But Effective Method

And that brings us to our last point. When you put all of the above together, you can easily streamline your approach and ensure that you’re using your resources to their full potential at every step of the way. The only way you can truly learn how to navigate the market efficiently is through some trial and error, but this won’t take you anywhere if you’re not evaluating your past actions to infer something new from them. With the help of backtesting, you can easily ensure that your approach to the market stays polished and relevant to the current situation.

If you haven’t applied any backtesting to your trading in the past, you’re going to have to take some time to learn how to properly utilize it in your own trading. But once you’ve learned the ropes, it can be an incredibly powerful technique that can bring a lot to the table. Just make sure to update your method regularly to ensure that it stays relevant to the market, and you will be able to progress much faster than you’ve done in the past.