Back Testing Strategies

Last modified 11:52, 5 Nov 2012

Back Testing Strategies

The ability to Back Test strategies is an important part of learning and validating whether the trading plan being applied to a market is actually performing as expected. The power of Your SOFTWARE is its ability to scan and find high probability trades on any date in the past and then step forward through these trades for subsequent performance evaluation. Strategies can be stepped forward by any selected timeframe. For more information on scanning for trades, see the Trade Scans topic.

Trading strategies can be constructed and analysed on any date in the past within the Option Analysis work page. The Back Test function can be accessed via the Action menu in the Strategy Tab page.

Back Test Via Strategy Tab

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The remainder of this topic will show users how to Build, Step through and Value a simple trade strategy using Your SOFTWARE’s built in Back Test feature.

Back Test a Trade Strategy

Enabling a Back Test

To enable the Back Test feature, click the Action menu and select Back Test from an Option Analysis Strategy tab page. A date picker control will be displayed on the main function bar which is used to select the date in the past to perform the back test as shown below.

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Use the date picker to select the date to test a trading strategy. The left and right arrow controls on the date picker will move the calendar dates backwards and forwards respectively by one month at a time. If a date in the future, weekend or market holiday is selected, there will be no option chains displayed in the main analysis data table.

To disable the Back Test feature, click on the Action menu and select Back Test. The option data chains will then revert back to the current date and any existing trades will be valued at the current date.

Building a Back Test Strategy

Building a strategy on a back test date uses the same process as building a strategy on the current market date. The only difference being a strategy is being constructed on a selected date in the past. For more in depth details on strategy construction see the Strategies topic.

This will be highlighted via a simple example of building a Call Option trading strategy on the stock Apple Inc (AAPL) by setting the Back Test date to the 6th February, 2012. See the above section Enabling a Back Test to select this date.

Selecting the 6th February, 2012 date from the date picker control will automatically load the option data chains for that date. The screen below shows the date picker control displaying the Back Test Date. The Last Traded date also reflects the selected date of 6th February, 2012.

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Any trading strategy can now be entered for testing purposes. A simple Call option will be used to illustrate this feature.

Entering a trade to Buy 1 Apr12 480 Call option will display all the trade and risk statistics in the Trade and Strategy Summary windows associated with this position. All figures reflect the prices and valuations on the selected Back Test date.

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The Risk Graph for the position can be viewed via the Graphs tab. The graph and risk statistics displayed will reflect the profile of the position on the selected Back Test date. Additional “What-If” analysis can be performed using the features on the Analysis Palette.

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The trade can now be Saved for future reference via the Save or Save As… commands or stepped forward by a selected timeframe to evaluate its performance. Saved trades can also be Opened and new Back Test dates selected, similarly to current market strategies.

Stepping a Strategy Backwards and Forwards

The ability to step a trade forwards or backwards in time is the essential ingredient for performing a back test. Your SOFTWARE has multiple ways of stepping trades forward or backward whether it is on a day by day basis or by any user defined timeframe.

Stepping Day by Day

Trades can be stepped on a day by day basis via the left and right arrows on the Back Test display control as shown below.

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By stepping one day at a time, the option chains for each selected date will automatically load and the trade will be revalued using the new market data showing, amongst other statistics, the new Profit/Loss figure. In addition, the Risk Profile on the Graphs tab will also be updated with the new market data.

Stepping by a User Defined Timeframe

The second way to step trades forwards or backwards is via a user defined timeframe. Users can select any timeframe to move a back test trade by clicking on the dropdown arrow on the Date Picker control and selecting any date forward. Once the date has been selected, the option chain data will load and the trade revalued. The example below shows the valuation date being moved to the 16th March, 2012.

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The ability to step a trade forward by any timeframe helps when testing time based exit strategies or option expiry dates. These dates can be directly selected forward by using the Date Picker control.

Valuing a Back Test Strategy

Valuing trades on a selected Back Test date is crucial when undergoing a Performance Evaluation for a given trading plan. The trade valuation is the basis for reporting the Profit/Loss on a trade in addition to the option “Greeks” and the Risk Profile shown on the Graphs tab.

Trade strategies automatically get updated and valued when back test dates have been selected. The screen below shows that new valuation of the Call option trade on the date set to 16th March, 2012.

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As can be seen, the trade is valued on the new valuation date of 16th March, 2012 and the Profit/Loss and trade “Greeks” reflect the new values.

The Risk Graph for the new valuation date can be viewed via the Graphs tab. The graph and risk statistics displayed will reflect the profile of the position on the selected Back Test date as shown below.

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The Back Test feature is a very important tool in a trader’s arsenal. Your SOFTWARE provides a great tool to help validate trades and learn how to make adjustments to trades when necessary. Any adjustments can then be stepped forward and revalued to see how the strategy performs in the market.

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