That's a mouthful, so I'll break down everything in this tutorial.<\/p>\n
I'll get into how to define a profitable strategy and how to do the testing to figure out the performance of a trading strategy.<\/p>\n
Then you'll put those 2 elements together to find out if a trading strategy really is profitable or not.<\/p>\n
Backtesting<\/h2>\n
![\"Backtesting](\"https:\/\/www.tradingheroes.com\/wp-content\/uploads\/Screenshot-2022-10-30-131244.png\")
<\/p>\n
The fastest way to figure out if a rules-based trading strategy is profitable is to backtest it.\u00a0<\/strong><\/p>\n Backtesting can be done in any trading market<\/a>.<\/p>\n When you can see that a trading strategy has a profitable track record over a long period of time, that's the best indication that a strategy is likely to work now and in the future.<\/p>\n Some people think that you need to know how to code a computer program to backtest.<\/p>\n That's simply not true.<\/p>\n You can do both manual and automated backtesting<\/a>.<\/em><\/p>\n Anyone can backtest.<\/p>\n This software<\/a> makes manual backtesting easy.<\/p>\n You can also use free charting platforms<\/a> to backtest.<\/p>\n It's just a matter of which one is easier for you.<\/p>\n All profitable traders look for trading strategies that have a historical edge in the markets.\u00a0<\/strong><\/p>\n Once you've proven that a strategy would have been profitable in the past, you'll also have key data on how that strategy performs.<\/p>\n You'll know things like…<\/p>\n All of these data points allow you to make important decisions about the trading strategy, which I'll get into more detail later in this tutorial.<\/p>\n Think about cars…<\/p>\n We all know that certain makes and models of cars last a long time and others break down quickly.<\/p>\n The reason we know this is because we have historical data<\/strong> that shows the reliability of these cars.<\/p>\n For example, Toyotas are generally very reliable cars.<\/p>\n On the other hand, Fiats are notoriously unreliable. So much so, that many people say that Fiat stands for “Fix It Again Tony.”<\/p>\n If you purchased a car from a company that just started producing cars last year, you wouldn't know how reliable those cars are because they don't have a track record.<\/p>\n So you're taking a big risk.<\/p>\n In a similar way, you need to know the track record of a trading strategy before you risk real money.\u00a0<\/strong><\/p>\n Again, backtesting is the best way to do that.<\/em><\/p>\n If you've never backtested before, this beginner's guide<\/a> will show you how to get started and the best tools that you can use.<\/p>\n Backtesting also gives you one of the most important traits that a trader can have…resiliance.\u00a0<\/strong><\/p>\n When you take a trade, you have a high level of confidence of your probability of having a winning trade.<\/p>\n You won't know exactly how each individual trade will work out.<\/p>\n But you'll know that if you take a lot of trades, X% of your trades will be profitable.\u00a0<\/em><\/p>\n The fastest<\/strong> way find that X% probability and your expected return is through backtesting.<\/p>\n Knowing the backtesting statistics of a trading strategy also helps you when you're on a losing streak.<\/p>\n All trading strategies will have a losing streaks, but you want to be able to separate a normal losing streak from a situation where your trading strategy may have stopped working.<\/p>\n For example, let's say that you had a maximum of 7 losing trades in a row in your backtesting.<\/p>\n That's normal for that strategy.<\/p>\n But when some traders start trading live, they freak out when they have 3 losing trades in a row and think that their system is broken.<\/p>\n If they have backtesting data and they reviewed their maximum losing trades in a row, they would realize that 3 losing trades in a row is well within the normal parameters of the strategy.<\/p>\n There's nothing to be worried about.<\/p>\n The same thing goes for the other data points you get in backtesting.<\/p>\n Therefore, having this data gives you the confidence to keep trading when you hit a rough patch.\u00a0<\/strong><\/p>\n Another way to figure out if a trading strategy is profitable is to forward test<\/a> it.<\/p>\n This basically means that you open a demo account or “paper trade”<\/a> to build a track record on a trading strategy.<\/p>\n Never risk real money when forward testing.\u00a0<\/em><\/p>\n The primary advantage of forward testing is that you'll know if a trading strategy works right now, in real-time.<\/strong><\/p>\n On the downside, it can take a long time to collect enough data to determine if a trading strategy works or not.<\/p>\n\n
Forward Testing<\/h2>\n
![\"Bitcoin](\"https:\/\/www.tradingheroes.com\/wp-content\/uploads\/BTCUSD_2022-10-30_12-34-38.png\")