Backtesting

I have always been a proponent of backtesting. Mrs EL told me this morning that I haven't written about it in a while so I am correcting the ommission.


While backtesting (or hypothetical trading as the U.S. government disclaimer calls it) is not a guarantee of future performance, it's pretty certain that what didn't work in the past is unlikely to work consistently in the future, assuming there have been no major changes. Further, not testing is living in hope.


Now there is backtesting and there is backtesting. Testing a pattern is more likely to be robust than testing specific indicator inputs. What this means is that if I observe something that happens at the beginning of a trend move and can capture that in code, then when that pattern repeats itself I can trade it and I can back test it. If my algo says that when widget 1 crosses above widget 2 then it will be less robust as the volatility of the market changes.


Now in Flo's algos, we have a stop loss. That stop loss is really a drop dead stop that is used if the other exit rules are not triggered. This drop dead stop may not be the best stop loss in the context of a particular trade or even of a particular day, but it's a number that Flo has found by looking back many days and deciding that if the stop loss is less or more than that particular number then the profitability over the whole backtest period would be less. So that stop loss is kind of an average number based on the average volatility over the backtest period. The same can hold true for a target if it is done in a way to look for the largest single number rather than trying to find first logical exit with a view to re-enter with new signals, looking for a very high win rate.


Better exits are dynamic exits that take into account the day to day and hour to hour volatility changes in the market.

The useful thing with Flo is that I can choose to work shorter hours. I have the benefit of stats that I can rely on so I can scale size in accordance with my account size and risk appetite. Remember, there are losing trades and they can happen any time. All it needs is for "they" to come in size and the best picture or setup can be a loser.


I didn't need to work too hard in the ES. Someone asked about yesterday's ES trades and you can see them on the chart. The setup has 3 targets but with current volatility the third target is the same as the second so 1/3rd of the position is exited at 1.5 points and 2/3rds at 3 points.

Go Flo!!!