Algo trading is becoming popular among traders due to unlimited number of Algo trading software introduced in the market. These Algo trading software are equipped with all types of trading strategies from simple intraday to complex option strategies. These strategies are also working in the various market conditions giving the promising results.

However, the success of the Algo trading software is highly dependent on the quality and quantity of training data with the right algorithms used to develop the programming of the software. And to check the strength and accuracy of such Algo software you need to backtest the trading strategies before you implement them into the live market.

What Does it Mean to Backtest a Trading Strategy?

Backtesting of a trading strategy in the stock market, especially of an automated software is the process of evaluating the performance of the trading strategies, how it would have been performed in past. The historical data is used to determine the potential and accuracy of the strategy in various market conditions giving valuable insights into Algo's performance.

Also Read: Top 10 Different Types of Trading Strategies in Stock Market

For backtesting you can use the historical data and check the performance whether it worked as per your expectations or how much it can give the returns or losses. It also helps to discover the potential flaws in the strategy and based on that you can modify the parameters or optimize the strategy before implementing it into the live market.

Why Backtesting is Important in Algo Trading?

The backtesting of such automated trading software is very important to evaluate the performance of Algo in various market conditions. Based on outperform or underperform, you can adjust the parameters or modify the other strategy as per the desired outputs. You can adjust the trading rules or change the entry and exit points to improve the returns and reduce the risks.

Also Read: How to Decide Best Entry & Exit Points in Intraday Trading

Another reason for backtesting the Algo trading strategy is to manage the risk associated with various types of trading strategies to minimize the impact of risks. Based on the outputs you can adjust the position sizing or modify the stop loss to reduce the chances of losses.

Also Read: How to Set Target Price and Stop Loss in Intraday Trading

When able to identify the performance and accuracy of the Algo, it will develop the confidence level for the traders to use the strategy in the live market for trading. You can rely on the strategy with the conviction that it will work as per your expectations even during the inevitable market conditions helping you to enhance the profitability.

How much Backtesting Would be enough?

Though, there are no restrictions on backtesting the Algo software, but unnecessary backtesting would be a waste of time and effort. In fact the need for backtesting depends on the complexities and risk with the expectations of reward from the trading strategy.

If you want to test a simple strategy, you need a few days or months of historical data to run the testing procedure. While, if you are backtesting a highly risky or complex level of trading strategy, then you need years of historical data to get the accurate results.

Backtesting is not a foolproof idea to judge the performance of the Algo trading software as during the real-time trading hours the trend and market conditions can change with unexpected scenarios. Hence, it is recommended to run the backtesting process many times under different types of market conditions with different time periods to get consistent results.

How to Backtest a Trading Strategy in Algo?

The backtesting process of trading strategy might differ from Algo to Algo trading software, but in all the cases, you have to use the historical data and backtest the strategy as per the market conditions and your risk profile and trading goals. However, for a common understanding, you can follow the guidance given below to backtest any Algo trading software.

Stepwise Guidance to Backtest Algo Trading Strategies:

Defining the Trading Strategy

In Algo trading first of all you have to define the criteria or parameters you want to apply in your strategy. You have to outline the conditions for entering and exiting from a trade position with the risk management strategy like using the stop loss to minimize the impact of losses. For accurate backtesting, a well-defined strategy in Algo is important for further analysis.

Also Read: How to Manage or Do Risk Management in Options Trading

Collecting the Historical Data

To perform the backtesting you need sufficient data of the market or underlying security on which you want to backtest your strategy. You have to collect the reliable data of the market or the underlying security. In the historical data, you need trading price, volume and trading-related other details that can stimulate your trading strategy. Make sure the historical data is accurate, as the output of the backtesting is highly dependent on the quality of the data.

Selecting the Backtesting Platform

Now you have to choose the right Algo trading platform or software where you can run your backtesting strategy. You can choose the Algo Test or any other popular Algo trading platform to use the data and implement your backtesting strategy. But make sure the data you are going to use in the Algo, would be compatible or able to use as per your strategy.

Implementing the Trading Strategy

Once you have collected the data and selected the strategy now you have to implement your strategy. To implement the strategy into Algo you can select the same data here and set the rules and parameters as per your defined trading strategy. To implement the trading strategy in Algo you should have some technical knowledge or programming and coding to set your strategy, define the entry or exit points and set the stop loss points.

Running the Backtesting Process

Finally, the next step is the execution of your strategy for backtesting as per your defined rules and parameters. Using your historical data the Algo will perform the transaction of buying, selling or exiting from the trade position as per the movement in the price. It creates a hypothetical trading process and based on the conditions it will show you the outcomes.

Analyzing the Backtesting Results

Now after getting the results you have to evaluate the performance of your trading strategy. To check the performance of your strategy in Algo, you have to analyse various factors like profitability or losses, time taken and rate of return on your investment. How much profit you earned or loss you incurred and the rate of return or ratio of the profitability. You can also calculate the losses or risk-adjusted return and winning rates or time duration taken for the returns.

Also Read: What is Profit Booking in Stock Market: Rules & Best Strategy

Tuning Your Trading Strategy

Based on the results and performance of your chosen Algo trading software you have to tune your trading strategy to make it perform better. You might have to adjust the parameters and add or remove the filters or need to modify the conditions to enter and exit from the trade position. The main motive for refining the trading strategy is to make it more flexible as per the changing market conditions to perform better and give you higher profits.

Repeating the Same Process

Once you have adjusted and refined your trading strategy you can now implement the Algo trading software to check the performance. Now using the previous historical or new data you can backtest the strategy again on your Algo and evaluate the performance with the same procedure. Again after checking the results if you are not satisfied with the outputs you can adjust or tune your trading strategy and run the backtesting again on the same Algo.

Tips to Perform Backtesting Effectively

Maybe you are not satisfied with the performance of your Algo trading software even refining many times you are not contented with the outputs, then how many times you will try to refine your strategy? To avoid such a situation or overcome this problem you need to keep certain things in mind so that you can get the best results from backtesting of your Algo software. In respect of the same, we have listed some useful tips for effective backtesting.

Define Your Trading Objectives

Before you start backtesting you need to define your trading strategy with clear goals and objectives so that you can perform the backtesting based on your trading goals and investment objectives. You need to define your risk exposure capability, time horizon and return of profits you expect from your trade positions. It will help you to set the parameters accordingly.

Use the High Quality of Data

Using high-quality data is very important to get accurate results from backtesting your Algo. Gather the reliable and accurate historical data with authenticated details and adequate time. The data should be collected from reliable sources with no manipulation and should be organised in such a way that it can be used as per the Algotrading format.

Nowadays you can also find the historical data in your Algo trading software which would be the best way to use the data for backtesting from the same source. The output or performances of backtesting results are highly dependent on the quality of data. Hence, always use the best quality of historical data sets to backtest the Algo to get the best results in various market situations.

Implement the Genuine Rules

While implementing the backtesting use realistic assumptions like actual transactions, impact of various factors, slippage and other factors that can affect the performance of the Algo. Genuine data and honest rules and conditions will help you to get accurate results that are practically possible and can be achievable while performing the backtesting. Apply the rules and targets or stop loss that Algo can achieve in the real world for the best results.

Also Read: What are the Top Factors Affecting the Stock Market in India

Unbiased Validation of Results

Last but not least, you need to validate the results obtainedfrom the backtesting with unbiased decision. Yes, any kind of emotionally influenced decision would be not a good practice to get the best results from your Algo. This kind of unbiased validation of results will verify the outputs of various trading strategies in various market conditions. It will not only help your Algo to give positive results but also reduce the risk from high-frequency trading.

Summary

Backtesting in Algo trading is the process of testing the performance of such automated software using historical data. It is important to backtest the Algo to ensure the trading strategy can work in various market conditions set on the predefined parameters or not. It not only helps to improve the reliability of users on Algo but also improves the chances of profitability at the same time reducing the impact of risk associated with the trading strategy.

Also Read: Types of Risks Associated with Investing in the Stock Market

To conduct the backtesting procure effectively you have to define your trading strategy clearly, and collect reliable and sufficient historical data. Further, you also need to find out the best Algo trading platform to implement and run your trading strategy. And you need to keep analyzing the results to refine your strategy accordingly and you can keep repeating this backtesting and strategy tuning prices till you are not satisfied with the outputs.

Here you can start Algo trading in Moneysukhto backtest your strategy with the best intraday Algo trading strategy with the best Algo trading platforms like Trade Tron, Quantman, AlgoBulls, Keev and TradingView like Algo-based trading software at the lowest brokerage charges. To enjoy the Algo trading at Moneysukh open demat and trading account right now and you will get one of the best online trading platforms at the best pricing in the industry.