Coming up with a new trading plan can be exciting. It can make you want to jump straight into the markets and use it to make you some lovely money, but should you be jumping in now? Have you actually tested the strategy out and can you be sure that it actually works? The only way you will find out the answers to those questions are if you thoroughly test it out.
Testing the strategies that you come up with can actually be seen as far more important than actually coming up with it. This is mainly due to the fact that anyone, even someone with no knowledge of trading could actually come up with a strategy. This doesn’t mean that it will be a good one or one that will actually work, but they will be able to come up with one. This is where the testing comes in, this is where you can differentiate between the good strategies and the bad ones, but it also offers far more opportunities than that.
So why do we test? We test for the simple reason of wanting to make sure it works. We do not want to get into a live trading situation nowhere we put a strategy into practice just to find that it falls apart or doesn’t actually function as a strategy. The strategy needs to have entry criteria, and exit criteria, and some risk management built into it, if any of those parts fail, so will the entire strategy.
We can test them in a number of ways, the best and most prevalent way of doing it is via a demo account, this account will mimic the trading conditions as closely as they can to live ones. This allows you to try out your strategy on something that could almost be considered a live trading scenario. If your strategy is successful here, then there is a good chance that it could be on the live markets too. It should be noted, that being successful for one or two trades is not enough, it needs to be consistently tested for at least a few months to know the full extent of how good the strategy is.
Let’s say you are testing a strategy and everything is going perfectly, this does not mean it will on a live account. While the conditions are similar, there are some distinct differences such as commissions and slippage, these do not exist on a demo account. So if you are taking small profits to be sure to take this into consideration.
There are also backtesting facilities available these take your strategy and will apply them to the last years of trading to see how it would have performed in the conditions that had occurred in the past. This can give you a small indication of how successful it could be in the future. This is not a 100% accurate testing method but can be used as a viability indicator.
So you found an issue, that is the whole point of testing. This gives you the opportunity to resolve that issue and then test again. This cycle should continue until you are 100% happy with the strategy, only at that time should you troy and deploy it onto the live markets.
Even with a strategy that works perfectly on a demo account, you need to stay disciplined, expect some losses, and always analyse and adapt the strategy as it needs. No strategy is full proof, they always need adapting and changing so be sure to stay on top of it and continue testing as the years go by.