Instead of applying a strategy to a time period going forward, which could take years, a trader can do a simulation of his or her trading strategy on relevant past data in order to gauge the strategy's effectiveness." Testing is a low risk way to try out a new stock trading strategy before fully committing to it. It is also an efficient form of technical analysis that will take minutes rather than months to conduct.
Because past results do not guarantee future performance, however, apply these techniques judiciously and cautiously. Do not assume that you will replicate the test results exactly when you begin trading. But testing stocks is still useful in that you will quickly determine (especially if you use automated back-testing software) whether a given strategy is a complete failure or a promising idea.
It is recommended that you examine the following criteria, among others, for effective strategy validation during back-testing:
· Net profit or loss
· Volatility--the maximum percentage increase and the maximum percentage decrease, and the delta between them
· The percentage return over one year, also called the annualized return
Be sure that the time-frame you select for encompasses both a "bear market" and a "bull market." You want to ensure the time-frame includes robust, healthy years of gains as well as less lucrative years when most investors experienced losses or middling results. If you only test using a span of years known as a bear market or a bull market, your results will be less realistic. You want to perform rigorous quantitative technical analysis and that includes examining different market conditions.
One useful function of annualized return is you can use your results to benchmark the performance of stocks against the past performance of investments in other categories. This might help you adjust your portfolio diversification strategy.
To obtain the best stock results, be sure to customize your settings (e.g., fill in the interest rates, average commission amounts, etc.), and enter as detailed information as possible. The more detailed information you can provide the software, the better and more realistic your results will be.
If possible, consider several different trading strategies before selecting one to apply; compare the different strategies against one another. Which test produced the most realistic results? This is likely a strategy worth paper testing. Note that the key question is which test was best in terms of producing realistic results, not which trading strategy returned the most profitable results. You are performing technical analysis for strategy verification, not to predict specific financial outcomes. You want to know if your chosen strategy is viable before taking time to explore it further.
There are multiple stock platforms available, ranging in price from free to several hundred or thousand dollars. To get the best bang for your buck, seek a back-testing software solution you can use as a cloud-based service on a temporary or annual subscription basis.
Matthew J Goss, Jr.,"What Is Back-Testing?", EzineArticles,
