Backtesting Is Not So Easy

With all the historical price data in place, and with some wonderful backtesting software, it should be pretty easy to come up with some winning strategies.

Actually it's not. And with good reason. Once you start backtesting, you should hopefully find that it's quite difficult to find a trading system that's profitable. Or at least decently profitable.

That's if your backtesting software works correctly.

And if you think about it, doesn't that fit with reality?

We don't have to make things incredibly complex to make money in trading, but then again it can't be so simple either. If everyone could make money buying when the close is above a simple moving average, and selling when it's below, well, everyone would be.

Then there is the fact that your entry rules are not the only thing you need to worry about when experimenting.

Your entry rules interplay with your stop loss management rules. Changing one effects the other. A trade is made up of both a buy and a sell.

Does your system lose a lot of money because your entry rules are saying to buy at the top of peaks, or because your stop loss is set too close to the price action? You'd really have to chart where your entries are, and how your stop loss is moved compared to the price.

Otherwise you might throw away a trading system that was consistently buying at absolute troughs (i.e. at the perfect time to buy), but was never given enough wiggle room.

Then there's the differences in personalities between the different currencies (e.g. EUR/USD vs USD/CAD). And the differences in personalities between the different intervals of the same currency (e.g. 5-Minute EUR/USD vs Daily EUR/USD). That is, you can't just copy your trading system to a different currency or interval and expect it's going to work the same.

You'd need to alter the entry rules or stop loss management rules. And as I said before, when you change one, you'll probably have to change the other.

You also can't copy a trading system that worked for stocks and expect it to do well with currency. It might, but it probably won't.

So even with (a) a lot of historical price data; and (b) a magnificent piece of software :-) it's still not a walk in the park to riches. But those with (a) and (b) have leapfrogged those without in terms of probability of success, as long as those people with both (a) and (b) continue to think for themselves.

Our software is called "Thinking Stuff's ATM", but it will only do exactly what you tell it.
 

Our Suggestion

Diversify. Not diversify like financial advisors want you to diversify - i.e. buy some stocks, some property, some fixed-interest, etc. Leave that for your retirement fund. No, I mean diversify in terms of trading systems. Don't get stuck to one. Looking around various trading blogs you can find multiple strategies, like Trader Mike and NR7, Chairman Maoxian and Trading For Dummies, I understand Trader-X has one, and there'll be others if you look. You'll have to experiment and adjust, but spend some time doing that and you'll increase your probability of success that much more.

There's also a myriad of e-books that you can buy offering "great" trading systems, but I've just about given up on them. If anyone finds one offering a purely mechanical trading system, please let me know.

See also:

• Example trading systems