Why Backtesting is Critical for Stock Trading

So you’ve decided to give stock trading a go. You’ve read afew books on technical analysis, and learnt the basics on candlestick patterns,moving averages, oscillators, and other technical indicators. You’ve eitherfound a stock trading system, or developed your own. Whether it’s a simplemoving average crossover, or a complex system involving Fibonacci, probability,trend lines, and oscillators, you will need to test your system. How will youknow if your trading system can be profitable in the future if it isn’tprofitable for at least some period in the past.
We all know the past doesn’t necessarily represent thefuture. All books, and websites online have that disclaimer. And it is true;Just because a trading system performs well in the past doesn’t mean it willremain profitable in the future. However, you may also want to look at it fromthis point of view. If a trading system continually loses money every year forthe past 10 years, what’s the likelihood that it will magically becomeprofitable over the next few months? If the graph showing capital over timelooks like a slippery slide, it is highly unlikely that it will look like amountain once you start trading with real capital.
If the current market is ranging sideways, then you would bemore comfortable going live with your real money if your back tests showed itwas profitable at least part of the time when the market previously rangingsideways. However, don’t expect profits in a ranging market if the system’s atrend following system. Not all systems are profitable 100% of the time. Someare only profitable during trending periods. Others are only profitable duringranging markets. There is no system that will be profitable in all different marketconditions. You will need to use your common sense when performing back testing.
There are many software programs available for downloadonline that will test your trading systems for you. Simply code in your buy andsell conditions, and the program will run through all the data it has, and spitout a report with the details of each trade placed, and the profit or lossoutcome. I personally recommend Amibroker, as this is what I used after someresearch online. I am not affiliated with the software company in any way. Ijust think that it is the most value for money software you can get online. Itis decently priced, and has all the critical functions you need. I don’tbelieve you should spend 6 thousand dollars on a piece of software, and thenanother 6 to attend the training course. Amibroker is a few hundred dollars,and will do the trick nicely. There is a huge support network online throughforums that are happy to help you with any trouble you have with the software.
You don’t have to choose Amibroker. Any other chartingsoftware will do. Once you’ve got that, its simply a matter of writing up yourbuy and sell conditions, importing Historical Stock Data into the software, and back testing your trading systems.
Good Luck with all your future trades.