Buy and Hold

The next couple of weeks, I'm going to try to put the spotlight on backtesting similar to what I did with money management a couple of weeks ago.  I'm going to bounce around the subject in no particular order but hopefully we'll all get something out of it. 

No matter what anyone says, I feel that backtesting is a very important part of trading.  I'd be very hesitant to jump into the market with a system that was never backtested and even though profitable backtested results don't guarantee future profitable results, backtesting will also help you become more familiarized with your system.   

Most trading software contains backtesting functionality built in and I've checked most of them out including eSignal, Metastock, Metatrader, Intellichart, and Amibroker.   Getting into detail is for another time but I just wanted you to see that you have a lot of options.  Most of these require some programming knowledge which is a limitation that some of you may have but you always have the option to manually backtest.  Unfortunately, manually going back in your charts is a very arduous and monotonous task.  In addition, sometimes you become very biased towards your system where you see only what you want to see. 

In its most simplistic form, backtesting is the process of going back in time and finding each and every trade signal that your system would have generated.  Using your profit target, stop loss, and additional money management rules, you will compile a list of both your profitable and unprofitable trades.  These can be further broken down into profitable long trades, profitable short trades, unprofitable long trades, and unprofitable short trades.

This brings me to a backtesting component that maybe some of you have or have not heard of which is the buy and hold strategy.  A buy and hold strategy assumes that you buy at the beginning date of your backtesting and hold the position until the last date of your backtesting.  The buy and hold profit is calculated by using the price on the first day and the price on the last day.  This will tell you how much you would have made or lost if you made one trade, opening it on the first day and closing it on the last.  What does this have to do with your trading systems backtesting results?  Ideally, your trading system backtesting should produce higher profits than the buy and hold strategy would have.  If this is not the case, trading your system would not have been worth the time or effort.  This is just one minor way to gauge how good your trading system was in the past and it's worth calculating because it's very simple to do. 

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