Backtesting is a valuable tool for traders of any skill level; however, it can be especially beneficial for novice traders looking to increase overall strategy and performance. Backtesting is the simulation of hypothetical trading strategies using historical data. It allows traders to evaluate their trading strategy’s performance over a defined period of time, assess risk and consequently make improvements to their strategies.
Backtesting can help to identify weaknesses in a trading strategy and can be used to implement tweaks or changes to improve performance. By doing so on a simulated trading environment, traders can avoid costly losses due to incorrect altering of strategies. Furthermore, novice traders can use this to gauge the strength of their strategy over multiple data points and develop a better understanding of what and how they are trading.
Though backtesting can enable novice traders to test strategies, it is not a fool-proof system; it is still important to do your own research and consult an experienced adviser. Carrying out backtesting requires knowledge about certain criteria and patterns in the market to improve your system; hence it is important to be familiar with key market terminologies and the application of different trading strategies.
It is important to note there are multiple trading strategies one can backtest. A few common strategies include momentum trading, range trading, carry and arbitrage. Momentum trading is based on the idea that assets that are rising in price are likely to continue to rise. Range trading is when an asset fluctuates between bounds and traders buy when an asset touches its lower bound and sell when it hits its upper bound. Carry trading involves buying an asset with a high interest rate and selling one with a low interest rate, thus making a profit on the difference. Finally, an arbitrage strategy is when a trader looks to benefit from price discrepancies, among different markets or between two related markets.
In summary, backtesting can be useful for novice traders looking to improve performance and strategy. It is beneficial as it enables one to identify weaknesses, develop understanding and evaluate strategies without fear of loss. Backtesting is also valuable for testing different strategies, such as momentum trading, range trading, carry trading, and arbitrage trading. It is important to ensure one understand different trading strategies, however, as backtesting alone will not guarantee success.
