All right, so how to backtest
a trading strategy.
I want to show you my three best
behind the scenes secret.
Now let's talk about backtesting.
What is backtesting?
Does it make sense to backtest
a trading strategy?
What are the pros, what are the cons
and what do you need to know when
backtesting a trading strategy?
So let's get started.
Number one, what is
backtesting?
You see, backtesting in general
is the method of looking
back to see how
well a trading strategy
has performed in the past.
So backtesting answers the questions
what results would I have
achieved if I had traded
this particular trading strategy
over the past few days, weeks,
months, or years.
So why does it
make sense to backtest?
Well, first of all, backtesting
has a lot of limitations.
Because some things
simply cannot be backtested when
you're looking back on charts.
One of the things that cannot be
tested is, for example, fills.
You never know when exactly
would you have gotten filled if
somebody would have taken the other
side of the trade.
And even if a trading strategy
worked in the past, there's
absolutely no guarantee
that it will work in the future.
However, if
a trading strategy didn't
work in the past,
it's also very likely that
it might not work
at all going forward in
the future.
See, this is why I think backtesting
is great to see if a trading
strategy has any validity
of being profitable.
For me personally, here is
the main benefit.
If I get solid results through
backtesting, I have more confidence
in the strategy and
it's easier for me to pull
the trigger.
Let me show you a very specific
example.
I want to show you something around
the PowerX Strategy because this is
my bread and butter strategy.
Now, I personally I'm
using a tool it's called the PowerX
Optimizer when I'm looking
at stocks for trading according
to the PowerX Strategy.
Let me jump on the screen and show
you exactly what
I mean by this.
So here you see the PowerX
Optimizer.
It's the software that I have
developed, not personally, I have a
development team that have done it,
but I have paid the bill,
according to my specifications.
So what this tool does, just
in a nutshell.
Every day it does find
the very best stocks
and options for me according
to the PowerX Strategy.
And what it does then if I'm
bringing up one of them, for
example, ACLS that
today is a "buy," okay,
according to the PowerX Strategy.
It shows me exactly
what would have happened if I had
traded this stock,
ACLS, according to the
PowerX Strategy over the past year.
And it's giving me these
results right here.
So on a $10,000 account,
I would have made $7,267.
So that is an ROI, return on
investment, of 72%.
I would have had 10 winning trades
and 7 losing trades.
So that's a winning percentage of
52.82%.
It would have had a profit factor
of 3.13
and the average winning trade
is $1,067,
the average losing trade is
$468. So here's the deal.
For me personally,
having these numbers
helps me to make a decision whether
I want to trade this stock or not.
I mean, it definitely beats the, "I
don't know how much money I would
have made or lost or if this
strategy would have worked at all on
this particular stock here."
OK? I want to show you a few things
right now that are super important
when you're backtesting.
Hey, but before we continue and I
give you the three tips and
I show you a few more things
on the PowerX Optimizer.
Let me know, is this making sense
thus far?
And am I going at the right pace
or am I too fast or too slow?
If I'm going at the right pace and
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Because one of my goals is to give
you no fluff, to give you practical
things that you can implement in
your trading right away to hopefully
help you to make more money.
So if thus far I'm doing good,
click on like. OK.
So now let's talk about the three
tips for backtesting.
First of all, tip number one,
you have to choose the right
timeframe.
Not too short, you cannot just look
back over the last week because this
way you don't have
enough data.
You want to look back long enough
that you have also different market
conditions. You want to have market
conditions where the market is going
up, where it is going down, where it
is going sideways.
You want to have a market that has
more volatility and that has
less volatility.
This way, you know exactly
that a strategy performs in
different market conditions.
Now, when it comes to the timeframe,
some people say, "Oh, you know what?
The longer the better." No,
that is not true at all.
Because if you use too
many years of backtesting,
the data gets diluted.
You see, for example, right
now, as we are recording this, it is
May 2020.
It does not matter how
a stock performed in
1972, right?
Which is almost 50
years ago.
So what is the
perfect timeframe?
Well, it depends whether you're
swing trading or day trading.
The PowerX Strategy that I
personally use is a swing
trading strategy that uses
daily charts, and therefore,
for me personally, I
like to use one year.
Now, let me show you exactly what
I mean by this.
And so I'm looking back here of
how else ACLS or
any stock performed over the past
year.
Because usually over the past year
there will be some times where
the market is rather quiet, there
will be some times where the market
is a little bit more excited, there
will be some times when the market
is going up, down and sideways.
So this is why I want to see
at least a year and
at least 12 trades.
Now, for this particular stock, we
had 17 trades according
to the PowerX Strategy.
So this definitely meets my criteria
and 17 trades give me
a pretty good idea if this
stock would have performed well over
the past year.
Now, I'm not planning to trade this
stock over the next year
or so, I'm only planning
to trade this stock for the next
trade. And if it has performed well
over the past year, it
is very likely that it will show a
very similar performance
over the next trade.
Is this making sense?
Again, with all of the limitations
that backtesting had I think having
some data is better than having
no data and just say, "Oh yeah,
this stock will perform well."
Anyhow, let's move on to
tip number two.
Tip number two is you need to
test each stock
individually and here's why.
For example, Apple is
behaving completely differently
than, let's say, Norwegian Cruise
Lines, right?
Obviously.
And even within an industry,
you have companies like Target
and Target is behaving completely
differently than, for example,
Macy's or Kohl's or
J.C. Penney.
So therefore, it is important that
you are backtesting the strategy
for every stock, and here's why.
Right now in the United States, we
have probably around 9,000
stocks that you can trade.
So the key question is which
stock is best suited
for this particular trading
strategy? For the PowerX
Strategy.
And that's what the software does
for me every night.
Every night it is going
through all the 9,000 stocks
and then finds the 8
to 12, or 2 to 8 best
ones that are perfect to trade.
So you cannot just say, "Oh,
I'm testing all stocks."
It doesn't make sense because each
stock behaves differently.
Let me show you exactly what
I mean by this.
So if you look at a stock like
Apple, for example, so here
is how Apple behaved
over the past year.
As you can see, mainly going
up, up, up then we had
this virus hitting us, right?
And the pandemic, so
it has been going down and right now
it is going up again.
Now, let's compare this to Macy's,
for example.
As you can see, this stock was
mainly going sideways
and then going all the way down
and not bouncing back.
Do you see how each stock is
different and therefore, you have
to look at each stock differently
and not go over a basket of stocks
but look at it different.
Anyhow. So that is tip number two,
you have to backtest each
instrument.
Is this making sense thus far before
we move on to the last tip?
Tip number three, which I think is
the most important one and I want to
show you what I personally do right
now in order to make sure
that the data that we got over
the past few weeks while we had this
pandemic going on, right?
I mean, this virus that basically
crippled the whole world
of how we can make sure that this
data is not distorting
our results. So if this is making
sense thus far you know the drill.
Give me a quick like and by the way,
if you're enjoying these kind of
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release a new video.
So let's move on to tip number
three. You have to backtest
with the right data.
So you need to make sure that the
data that you're using for
backtesting is representative
for normal market conditions.
That is a key point.
The key here is normal market
conditions.
Now, if we look back and we go on to
the charts here right now, we know
that in late February and
March 2020,
the markets were crazy.
Now, again, backtesting
answers the question, what
would have happened if I had
traded Macy's
over the past year according
to the rules off the
PowerX Strategy? And clearly,
I mean, if you have been following
me here on this channel for a while,
you know that I said over the past
few weeks why we had
this dramatic meltdown
I did not trade the PowerX
Strategy because it is a strategy
that is designed for normal market
conditions.
What I did is I sold put
options, so I traded a strategy that
I called the Theta Kings, right?
So I did something different.
Therefore, if right now I look
at all these trades and
say, what results would I have
achieved if I had traded this
stock over the past
year, I have to
exclude the time when I
clearly would have never
traded it because the markets were
crazy. Now, this is where
I'm doing something that I feel
is super smart. And I'm usually not
that smart, but this is why
I decided to do the following.
From all the results
I want to exclude what happened
over the past week because I would
not have traded it anyhow.
So let me show you exactly why
and why it is so important.
This tip number three, backtest
with the right data, is
probably the most critical tip.
So, what my software does it shows
me exactly the trading
report where it shows me every
single trade that I would have
taken according to the rules of
the strategy.
And what you might see, we got a
profit of a total of $7,267
based on a $10,000 account.
So what is it?
72% ROI.
But you see that here, between
2.27 and 3.19
while we had this pandemic going on,
we had one trade
that generated
$4,300.
So out of these
$7,300, one trade,
one trade is responsible
for more than 60% of the profits.
So should we exclude this?
Absolutely.
Because is it likely that the market
will crash again over the next
few weeks or months?
Maybe?
Probably not, right?
So this is why I want to see
what are the results like if I'm
excluding the trade.
So I want to show you behind the
scenes because I promised behind the
scenes. This here is
the development version.
So if you're looking at the same
symbol, ACLS,
that we just looked right now and
we bring it up you see, I am right
now, this why it is shaded here
in gray, I am excluding
the area from February
to late March because this is
when the markets were crazy.
And here's what you will see that's
happening.
By excluding it the profits
go down from what was it?
$7,300 to
$1,300. Now you look at the stock
again and say, would you trade
this stock if...
Because if you had traded it
according to the rules of the PowerX
Strategy over the past
year, you would have only made
$1,300. Is this making sense?
Let me show you another example
because this is why it is so
important.
You can not include
data that is distorting the results.
I want to show you BHC.
Right now it shows that if you
had traded BHC
according to the rules of the PowerX
Strategy on a $10,000 account you
would have made $9,451
over the past year.
12 winning trades, 9
losing trades, 57%
winning percentage, and a profit
factor of 3.77.
However, if you now look at the
trading report, you see that out of
this
$9,451, 3 trades
happened during this crazy time.
And these 3 trades are responsible
for around
$7,000,
$6,500 - $7,000 of this
$9,400. This is not
normal market behavior.
So let me show you when I'm
excluding this
BHC what happens here to BHC.
So what I'm excluding these crazy
times you will see that now.
I'm only making
$3,400.
Still have 10 winning trades, 10
losing trades, 50% winning
percentage, but the profit target
went down from 3.
something to
1.86.
See, this is why it is so
important that you backtest with the
right data, and this is why right
now my development
team has worked on excluding
it so that we get the right data.
So backtesting has its
flaws, but backtesting
can help you to test if
a trading strategy works at all.
And that is true for me,
it can give me more
confidence to pull the trigger.
Because let's face it, what is
the one thing that makes
traders not
pull the trigger?
That they don't have confidence,
that they don't believe in the
trading strategy, that they second
guess themselves.
I know that for a fact, that's what
I did in the beginning of my trading
career. I saw a perfectly
great set up according to my
strategy and then I was wondering,
"Hmm, should I actually enter this
trade or not?"
And, you know, you snooze, you
lose. By the time I made the
decision, the trade was already
gone. Anyhow, so if
done right backtesting
is an important tool for a trader.
But this is why you need to apply
these three tips that I gave you in
this video so that the backtesting
results are in fact, relevant
results that you can use
in your trading.
And when you do it right, it will
help you with your confidence and
make sure that you are trading
a strategy that has all chances
of success.
Always keep in mind, when trading,
we never know for a fact
if something will happen.
We don't know for a fact, if in the
future the strategy will work.
It's all about putting the
odds in our favor.
And this is what back testing
can do, it can help you to put
the odds in your favor that you are
trading a strategy that
works.
Hope that helps. And if you enjoyed
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