One quick note, many people have e-mailed me saying they cannot get some of
the systems I wrote about in High Probability Trading to work for them. There
is a reason for this. I wrote them using TradeStation 4.0, currently they are on
Version 8.3, and somewhere along the line they changed the way you enter
systems. Before, you would write one long system with all the signals in it. Now
it’s broken up into different segments for entries and exits, making it a little
different.
If you don’t have a fancy program to analyze your trading ideas you can
always do it by hand. You can pretty much get free charts of anything on the
Internet, even intraday charts. Print out what you need and then manually
go through it and write down your entry and exits and how you would have
done. Your goal is to come up with a strategy that has worked in the past.
Because if it didn’t, odds are you will not make any money trading it in the
future.
When you do back test, make sure you take into account two sometimes
forgotten elements. One is commissions and fees and the other is slippage. Commissions can quickly turn a winning system into a breakeven
one, because not only do you have to make a little extra on your winning
trades to cover costs, you also have to cover the commissions on your
losers. Slippage also can be deceiving. Slippage is the cost associated with
trading that is the difference between where you think you will purchase or
sell something and where you actually do get it. For example, if your system
gives you a signal to buy at the market when the price reaches above
93, your system may show 93.05 as the entry point, but in real life you will
probably get 93.10 or worse if the market is moving fast. Here is an example
of the power that commissions and slippage have to hurt you:
You get a signal to buy at 93.00, at the time the market is 93.00 bid,
offered at 93.05, so you pay 93.05. An hour later it’s still trading at around
93.00 and you want to exit. However, this time the market is 92.95 bid at
93.00, so you get filled at 92.95. Your commission on the trade was $8.00
for 1,000 shares. So you end up losing $100 on the trade itself plus another
$8 on the commission for a total of $108 in a stock that was virtually unchanged.
Your system would have it as a wash, getting in and out at 93 even,
but in reality you took a loss. So don’t take these costs for granted and learn
to incorporate them into your back testing if you want to stay realistic.
Another important reason for back testing is to find out the biggest
drawback and longest losing streak of the system. You may think you have
a great system because it is positive, but what you may not realize is that
it normally has 10 losses in a row and can lose as much as $10,000 during
a bad streak. This is something you would want to know before trading it.
Maybe these losses are too much for you to handle and, as such, you would
not be able to trade this system successfully as you would second-guess it
once a losing streak occurred. Remember, you need to be comfortable with
a system in order to trade it properly.
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