We have a potential trading idea, and we would like to see if it is worthwhile. Is it really critical to code it? No. But very convenient? Yes.
Manual historical backtesting
There is no need to code the strategy to do an initial validation test. All we have to do is pick a chart, go back in time and start performing trades manually. But how to do it properly?
- Use a trading log spreadsheet, as the one forex.academy provides.
- Thoroughly describe the methodology, including the rules for entry, stop-loss, and take-profit settings.
- Use a standard 1 unit trade size ( 1 lot, for example) in all the trades.
Once the rules of the game have been set, we position the chart, start moving the action one bar at a time, and trade the chart’s right side. It is critical to take all the signals the strategy offers. Cherrypicking spoils the test.
The financial markets move in phases. We should think it has two main phases and three directions.
The two main phases are impulses and corrections.
Bear and bull directions are mostly similar in the Forex market because currencies are traded in pairs, so the quote currency’s bear market is the base currency’s bull market and vice-versa.
With commodities, precious metals, and cryptocurrencies against fiat, this does not hold.
To properly test your strategy, you should apply it in all market directions and phases. Even better is performing a different evaluation for each market state. That way, your evaluation will tell you in which market conditions it works best and in which is not acceptable to apply it; thus, you could create a complementary rule to filter out the market phases in which the strategy fails.
You must apply the strategy to all markets you intend to trade using it. As with the market conditions, you should test each market separately. After having all markets tested, you will find useful information regarding how markets the strategy works best and the correlations among markets when using it. That applies, of course, if you use the same timeframes and periods in all markets, which is advisable.
If you do it as said, you can also perform the summation of all markers date by date and assess the overall performance, its main parameters, and system quality.
Pros & Cons of manually backtesting
- No programming skills are required.
- It helps you perceive how a real market evolves trade by trade.
- You will find the potential logic errors, such as stop-loss wrongly set, take profits too close to the opening, thus
- You will be able to correct most of the gross mistakes of the strategy.
- Cherrypicking. Discipline is key. If you start cherrypicking, you no longer are testing your original idea.
- Most people doing manual backtesting do not properly trade all phases and markets. Not always thoroughly test all markets and their conditions, as it would require a lot of time. Thus the test is incomplete.
- Time-consuming. A complete manual backtest takes much longer than a computer-generated backtest.
- Awkward optimization. Optimization is also tricky and time-consuming. That is so because a parameter change would need another backtesting.
Manual backtesting allows us to have a first impression of how a new trade idea would fare in real trading, but a thoroughly manual backtest and optimization are time-consuming. Therefore, serious traders should start developing basic programming skills to automate both processes.