June 3: Discover Why Back Testing Your Trading System Automatically Increases Your Confidence

by Dave on June 3, 2006

After you`ve set your initial stop loss, chosen your method for calculating your trailing stop loss, and implemented all your money management rules, there is one last thing you should do. Back test your system. With out back testing you will be headed in the right direction, but you won`t know what to expect from your system. Back testing will also give you the confidence to keep going when you begin to experience the doubt that every trader faces at some time.

You back test your system by applying the rules and conditions of the system to the stock`s historical market data. However, this is only possible if you`re trading a system that is entirely mechanical and does not require any human input to place the trades. How do you know whether or not your system is completely mechanical? Can you take down your trading plan, the set of rules and guidelines that you follow, and hand that over to someone else, who could then trade the same system and receive the same results as you would if they followed the system carefully?

If you can do this, you have a mechanical system. If you can`t, you should look at implementing a completely mechanical system. Perhaps one of the hardest parts in trading any system is to have the confidence to stick with your system. In fact, a mechanical system almost forces you to make decisions that are in direct conflict with what your gut feeling might tell you to do.

Remember, our gut feeling tells us we should hold on to losing stocks until they get to the break even point, and our gut feeling would tell us to sell shares as soon as we`re a little bit in profit. Obviously, a mechanical system goes against these human tendencies, and that is one of the reasons why it`s psychologically difficult to trade. However, you can back test a mechanical system.

While back testing will not tell you with 100 percent accuracy what the profitability of your system will be once you start trading it, it will give you a very good sense of what you can expect. All prices are driven by the same two factors, supply and demand, in the present and in the past. So even though price movements are never going to be exactly the same, there will be patterns, and similar movements that show up over time. With back testing you can discover the how profitable you system is likely to be, and how often you are likely to have a loss rather than a profit.

As long as you make sure you back test your system over different market conditions, it can be reasonable to draw parallels as to the performance of your system historically to its performance trading it in real time. Knowing this will make it much easier to stick with your system, and the profits you can realistically expect will start coming in.

This article has been extracted from David Jenyns` Trading Secrets Revealed Course. Unfortunately this course is currently sold out. To be notified if and when extra copies are released, please send us an email and we`ll let you know when you can purchase a copy of this highly recommended course. Click Here and send us an email. and be sure to mention you want to be on the `Trading Secrets Revealed Waiting List`.


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