Introduction

Back testing refers to testing a trading plan with historical data to see how it would have performed during that particular time period. The rationale for back testing your trading plan is that any plan that work well in the past is more likely to work well in the future, and vice versa. As a trader, back testing your trading plan provides the opportunity to optimise and improve your strategies before executing the plan with real money.

Back Testing for Beginners

Most people relate back testing with complicated programming on trading platforms. However, that is not always the case. Being a beginner in trading, you can back test your trading plan in various simple methods before executing your trading plan just by observing events that have occurred in the past.

For example, your trading strategy is to place a trade when the stock price breaks out to a high of past number of days/weeks which is a sign of switching from accumulation phase to markup phase (refer to previous “iVSA Article 6 - How to Detect Smart Money Movement” http://klse.i3investor.com/blogs/ivsatradingtipsandplans/96519.jsp) about accumulation phase and markup phase). To back test your trading plan, when you have identified a potential stock, you can trace back previous price movement of the share and identify whether there is such pattern occurrence in the past.

Below is an example of price movement for a real company share listed in the Singapore Exchange (SGX).

• Picture 1: shows its price movement from 27 Mar 2015 till 27 Jul 2015 (4 months). As you can see the horizontal blue box marks the accumulation phase while the vertical purple box denotes the markup phase.

• Picture 2: shows its price movement from 4 Jan 2016 till 4 Apr 2016 (3 months). As you can see again the horizontal blue box marks the accumulation phase while the vertical purple box denotes the markup phase.

As you have back tested your trading plan and obtained 2 successful occurrences from the past, very likely the 3^rd occurrence will happen when the accumulation phase is ongoing. If the share of interest does not show any price movement patterns which correlates to your trading strategy, most likely your strategy will not work for that particular share.

Forward Testing

Another method of testing your trading plan is to do forward testing, which is also known as paper trading. There are many software or online platforms that provides simulated trading accounts where you can place a trade with paper money instead of real money. This allows you to further test your trading plan and gain confidence before executing your trading plan with real money.

The only downside of this method is that more time is needed to prove positive results for your trading plan. However, although more time is needed, this is very effective in building your confidence before entering the market and trade with real money.

Conclusion

Back testing is an important aspect in developing a winning strategy for trading. It not only increases confidence in executing the trade, it also helps to reduce the risk of using wrong strategy but on a right share or using the right strategy but on the wrong share.

Watch out for next article in this series of education articles brought to you by iVSAChart, “Article 10 - Recognise your Risk” under Series B: Preparation Before Trading or Investing (what professionals worldwide are practicing).

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This article only serves as reference information and does not constitute a buy or sell call. Conduct your own research and assessment before deciding to buy or sell any stock. If you decide to buy or sell any stock, you are responsible for your own decision and associated risks.