LIGHTING THE PATH TO PROFITABLE TRADING (the whole tutorial handbook pdf Free Download)Backtesting is essential in stock trading because it allows you to evaluate the performance of a trading strategy based on historical market data. By backtesting a trading strategy, you can determine how well it would have performed in the past, which can give you an idea of how well it is likely to perform in the future.

Backtesting can also help you identify any flaws or weaknesses in your trading strategy. For example, if your strategy performs poorly during certain market conditions, you can modify it to improve its performance in those conditions.

In addition, backtesting can help you set realistic expectations for your trading strategy. By evaluating its performance over a long period, you can get a good idea of the average returns and drawdowns you can expect from the strategy. This can help you avoid overestimating the potential profits of your strategy and taking on too much risk.

To perform a backtest, you need to:

Define the rules of the trading strategy: This involves specifying the entry and exit conditions of the strategy, such as when to buy or sell a stock based on certain technical indicators.

Gather historical market data: This involves collecting price data for the securities you are interested in over the period you want to backtest.

Apply the trading strategy to the historical data: This involves simulating the trades that would have been made by the strategy at each point in time based on the historical market data.

Evaluate the results: This involves analyzing the performance of the strategy in terms of its profitability, risk, and other performance metrics.

Let's consider an example of how backtesting works in practice. Suppose you want to develop a simple trading strategy for a particular stock. Your strategy involves buying the stock whenever its 50-day moving average crosses above its 200-day moving average (a so-called 'Golden Cross'), and selling the stock whenever the opposite occurs (known as a 'Death Cross'), as shown in the chart below.

To backtest this strategy, you would need to gather historical price data for the stock and calculate its 50-day and 200-day moving averages at each point in time. You would then simulate trades using the trading strategy and calculate the profit or loss that would have been made at each point in time.

For example, we can create a VBA macro to perform backtesting for the "Two Moving Average Lines Cross" trading strategy. Do you remember the "10-day SMA and 100-day SMA" strategy code we mentioned in Chapter 1? We can modify it, change the short term SMA to 50-day, and the long term SMA to 200-day. Let's take AAPL (Apple Inc.'s stock symbol) as an example. After downloading AAPL's historical data (2011-01-03 ~ 2023-02-23) and running the VBA program, we will get a result like this:

The result may not seem impressive, eh? The trading strategy looks perfect, the company is famous and strong. But when we deploy this trading strategy, the result is just so-so. This case shows why a backtest can protect us from guesswork and mystery, and a simple VBA program can save us a lot of time and money.

After performing the backtest, you would evaluate the results to determine if the strategy is profitable and if it meets your risk and performance criteria. For example, you might evaluate the strategy based on metrics such as the average annual return, maximum drawdown, and Sharpe ratio.

If the results are satisfactory, you perhaps can use the strategy to make trades in real-time. If the results are not satisfactory, you may need to refine the strategy or develop a new one altogether.

Let's go back to the 'Two Moving Average Lines Cross' trading strategy, and adjust the parameters by setting the short-term SMA to 5 days and the long-term SMA to 50 days. This will increase the chances of executing the strategy. The chart will look like the one below:

Run the VBA Macro again.

Look at the results above, much better, right? Let's dive into the details:

The Annual ROI (Return on Investment) is 9.59%, which is higher than the average Annual ROI of the S&P 500 index (6.9%). See the difference? With the same trading strategy, same target, and same time period, just changing some parameters can lead to significant differences in the result. If you do this manually, it may take several days, if not weeks. However, by using VBA, it only takes several minutes or hours. Conducting a backtest, it may seem like playing a game of numbers. However, without it, we risk facing Life-or-Death situations in real trading.

An Annual Return on Investment of around 10% is decent, OK but not a “WOW!” yet. Compared to Warren Buffett's average ROI of 17% per year, there is much more room for improvement in the trading strategy. The process of improving the strategy can be full of interesting discoveries and surprises. We will continue to share more backtesting details in the following chapters. For example, if we change the short-term SMA to 20 days and set the long-term SMA to 50 days, like this:

We can double the ROI to 18%, which is neck-and-neck with Warren Buffett's performance, as shown in the chart below:

Now, backtesting brings us a small "WOW!", doesn't it? Eh? In the following chapters, we will explain the details of every part of VBA Macros which deploy different trading strategies for different targets. Stay tuned.

In summary, backtesting is an essential step in developing and evaluating trading strategies. It allows you to test a strategy on historical market data and determine its performance and potential profitability. Backtesting helps traders make informed decisions and avoid costly mistakes when investing in the stock market. Without it, you would have no way of knowing whether your strategy is likely to be profitable or not, and you would be trading based on guesswork and intuition rather than solid evidence.

As you can see, the difference between a profitable trading strategy and a losing one can be as small as a few parameter tweaks. In fact, some might say that trading is just like cooking: you need to adjust the recipe until it tastes just right. And if you're really good, you can make something that's not only tasty but also nutritious. So go ahead, put on your chef hat and start backtesting your trading strategies. Who knows, you might just cook up the next big thing in the stock market!

LIGHTING THE PATH TO PROFITABLE TRADING (the whole tutorial handbook pdf Free Download)
A Step-by-Step Guide to Building a Trading Strategy Verification Tool with VBA Macros


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