Learn How to Trade Profitably

By John Pontikas and Brian Dibbins

Chapter Twenty Six

Back Testing and Paper Trading

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This chapter covers the importance of backtesting and paper trading any stock or market you intend to trade, so that you can learn whether that stock (or market) is likely to be profitable with your system.

Back Testing and Paper Trading

Prior to trading any stock/market, we always perform a backtest on it. Every stock/market moves independently from one another.  Some are primarily trending, whilst others tend to move sideways the majority of the time.  We are only interested in the trending stocks and markets because we have found them to be the most profitable for our systems.

Before trading any particular stock/market, we need to know that our trading system suits it, and that we can be profitable.  So, we backtest our entries and exits of the last five years on dead data and compare the results with other stocks/markets that we have backtested.  The best and most profitable stocks/markets are then entered into our watchlist.

We backtest at least five years worth of data because within that time frame, the stock/market would have had experienced uptrends, downtrends and sideways movements.  This information provides us with accurate data regarding how that particular stock/market performed under most conditions.

The backtest also assists us psychologically and emotionally, because we understand how the stock/market reacts and moves in different economic conditions.  The backtest will show us if the stock/market has sudden fluctuations, whether it’s volatile and whether it’s subject to frequent corrections or crashes.

Backtesting five years on daily and weekly charts is very easy, but next to impossible on intraday charts.  Instead of backtesting intraday data, we prefer to paper trade it live.  This is especially relevant to the futures and currencies markets.  Intraday trading requires quick decision making and the only way to put one to the test is to sit in front of the screen, and pretend to trade without placing real money down.  We paper trade live for at least four weeks before we place real money down.

Once again, preservation of capital is our first priority, and these are the necessary steps that must be taken in order to prepare our subconscious and to give us faith and confidence in our system.

The following is some of the information we include in our backtest and paper trading: Name of stock/market, Date of entry, trade number, buy/sell, price of entry, contracts, account balance, risk %, price of exit, comments, profit/loss, total.