PWB#5: Impossible Trading Systems
If you create a trading system that buys and sells about 80 times a day, essentially that system is impossible for a single human to trade. Either you would need to automate it, or have a group of people so you could get some sleep at some point.
If you can only guarantee you can be at the computer between the times of 2pm and 4pm, then your backtesting cannot scan data over the entire 24 hours of the day. It must only use data available between 2pm and 4pm.
If your account does not allow hedging (that is, holding both a long and short position in the same currency in the same account), then backtesting a system that hedges is pointless. (Although you should be able to set up two accounts - one for your long trades and one for your short).
A post over at Trader Eyal shows another type of situation where your backtesting might not reflect the reality - he wanted to go short on some stocks, but the broker he uses did not have any of that stock available. This is for stocks, I'm not sure currency would have the same situation, but there it is.
I'm running out ideas for my "Problems With Backtesting / Common Mistakes People Make While Backtesting" series. Any ideas?
To summarise: The holy grail of backtesting is to get it as close as possible to real life trading. Should you have true and accurate tick data, backtesting can be very close to reality. But, most people have just daily data. Sure we know the open, high, low, and close, but assumptions need to be made about what happened during that day. As long as your assumptions are reasonable, and lean more towards the pessimistic than optimistic, then accurate backtesting can still be done.
Inaccurate backtesting is a waste of time. And will probably end up a waste of your money, too.
When we have accurate backtesting, we can start to filter the good trading systems from the bad. And then start trading the good systems in a demo account. Testing your system in a demo account requires no assumptions. Do well there and you should do well in real trading (forgetting for a second about trading psychology and emotions and all that :-)
3 Comments:
Heya Mark, a common problem I found with WealthLab is coding systems which 'forwrad look'. For example using the day's close data for decision making (pure price or indicator value) and executing on that same bar when the entry should only be done on the next bar. You kind of covered something similar with #2.
With stocks there are also issues with slippage, partial fills, markets only opened for half a day (timed exists need to be tweaked). It's also difficult to account for stocks getting suspended from trading. Other issues are around which stocks get backtested, if you trade news then it's difficult to have this data as part of the backtesting. Last one, portfolio and position sizing when trading multiple positions concurrently, making sure your account can support 5 open trades or 5 contracts etc.
That's all I remember for now from some amateurish forays into backtesting. I'm sure you'll be able to comment on these in much more details than me :)
Cheers
Eyal
No, I think you did just fine :-)
Just for your info: There is no problem at all going long or short currencies, as actually, the moment you go short one currency, you are obviously long the other. EG You seel the USD against the euro. Meaning you are short the USD, but long the Euro currency.
Also there is no restriction going long or short index futures or any other futures contract, as for every contract traded you need 1 buyer and 1 seller.
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