Before buying a phone, laptop, or anything else, you want to ensure it works. In trading, you should do the same thing. You can’t use your trading strategy on the real market until you’ve tested it or at least know what it might do. This is why you need to backtest it.
How does backtesting work?
A common pattern for new traders is to devise a strategy that seems to work, use it for a while, and then stop using it after a string of bad trades. Then they try new things, and the cycle starts over again. Because of this, many stop trading, because they think no one can consistently make money on the crypto market or that crypto trading is not for them.
So, instead of stopping to use a trading strategy and picking another when you start losing trades, you can test your strategy with data to see how it would have done over time without risking any money. If this strategy works, you’ll have more faith in it because of the result.
Backtesting lets you look at historical data to see how your crypto trading strategy might have done in the past. The idea is that any result a strategy has had will likely happen again. So, a strategy that works well when tested with historical data has a good chance of working well in the future, and the same is true the other way around.
4 Reasons to Conduct a Backtest of Your Trading Strategy
A Zero-Risk Strategy
When you backtest your trading strategy, you won’t have to put any of your trading capital at risk. Backtesting is a great way to test your trading strategy without using a real trading account.
Fine-Tune Your Strategy
Backtesting shows you where your strategy works well and where it doesn’t. Then, you can use the information to change the strategy to fit your trading style and needs.
More confidence in your trading plan
Backtesting lets you try different ways to trade on the market to pick the best one. This will give you more faith in your strategy, especially if it works well across a wide range of market data.
Find new ideas
Since backtesting gives you access to a lot of data, you will likely see more repeating trading patterns. This can help you come up with new ways to trade.
2 Techniques for Backtesting Your Strategy
You can either do it by hand or automatically backtest your crypto strategy.
If you want to backtest your strategy manually, you will have to place trades on the historical data yourself. To do manual backtesting, you need to do the following things.
- After signing up for an account with a reputable crypto exchange, open the chart setup for the asset you want to buy.
- For backtesting, you need a plan. It would assist if you thought about the tools and indicators you want to use. For example, you could use the Fibonacci retracement tool to trade bearish or bullish trend rebounds on BTCUSD within an hour after the price bounces off the 61.8% level. For the move to be valid, the 61.8% Fibonacci level must also meet the trendline.
- Now that you have a strategy, you need to scroll back to where you want the backtest to begin. When it comes to BTCUSD, you can go as far back as 2013. Then, you can look at the one-hour chart for trends to see if the trend is likely to continue after a retracement that meets your requirements.
- When you see a relevant setup, use the tools and indicators you want to test on the chart. In this case, the trend line and the Fibonacci retracement tool. Then, draw the chart of how you would have if you had been trading when the move happened. Afterward, move your chart forward one candlestick at a time to see what happened. The idea is to slowly move the chart forward to see how the trade turns out and then write down what happened.
- As you write down the result, you can keep scrolling to get more setups, use your trading tools to analyze them, and move forward to see what happened. Keep doing this until you’ve looked at a lot of data. Some platforms, such as TradingView, let you automatically play and pause the historical data, so you don’t have to scroll. You can also change how fast the video plays back on the chart. This is for Pro, Pro+, and Premium users of the platform.
Manual backtesting can help you better control your bad trading habits because you will be emotionally involved. You also don’t need to know how to code to use this method. On the other hand, manual backtesting takes a lot of time because you have to look at a lot of old data to get your results. When you keep track of your past data or results, mistakes are easy. Backtesting by hand is also more time-consuming if you want to look at more than a one-time frame.
This backtesting method lets you use technology to check if your strategy works. Usually, coding is used to make the process go more quickly. It makes it easy and quick to test your strategies over a long period.
Then, you can use the data to determine if your plan is working and what to change. Backtesting that is done automatically works like backtesting done by hand. You will also have to pick a time frame, an asset to trade, and a strategy to test.
You won’t have to manually configure each operation, record each order, and calculate profit and loss. All of these things happen on their own. The biggest problem with an automated demo account is that you may have to know how to code or easily access people who know how to code.
3 Important Backtesting Tips for Crypto
Don’t Pick and Choose With Data
Make sure you use a variety of data sets, not just the ones that look like they will help your strategy. It would be best if you didn’t trick yourself by only using data from the past that makes your strategies look good. If you do this, you won’t be able to use real-time data well.
You don’t have to hurry. If you are thorough, you will be able to find flaws that simple backtesting might have missed. Don’t forget to look everywhere. To be thorough, you should use as much data as possible to see how your strategy works in various market circumstances.
You’ll never find the perfect plan.
Every strategy has flaws or times when it loses a lot of games in a row. All you need to ensure is that whatever able-to-trade style you choose will be profitable in the long term and give you the desired result. To make this happen, you must also use some risk management techniques.