Back Testing and Field Testing: An Introduction to the Keys to Your Success as a Trader
Building a stable spread betting strategy is crucial to your success as a trader. That is why it is not enough to just pick a strategy out of any old spread betting book and run with it. You must be willing to test the strategy extensively before deciding to add it to your repertoire.
There are two popular methods currently being used to test trading strategies: back testing and field testing. Moreover, in today's article, you are going to learn the basics of each strategy: what they are, how they work, including a few of the advantages and disadvantages for each.
Most traders start testing their strategies with back testing. The premise behind back testing is to check a particular strategy against events that have previously happened.
Via back testing, you can gain a deep understanding of how a particular approach performed under past market conditions. Then based on your findings, you can construct a working hypothesis of how that strategy will work in a real life scenario (which you'll test it against later on).
Advantages of Back Testing
- Helps uncover when a particular strategy will have the strongest positive effect (read: earns money) and which conditions will need to be in place in order to achieve that effect.
- Can instill confidence into the trader that the strategy can, in fact, potentially work.
- Forces the trader to get specific about their strategy. For instance, instead of merely stating they are going to "sell high", they are forced to ask themselves what they consider to be "high."
Disadvantages of Back Testing
- Can breed a false sense of confidence of how the system will perform in real-time based on how it performed in the past.
- Does not factor in various outside factors that an algorithm, software, or code cannot control or take into account.
- Based upon historical data that may not be guaranteed to repeat itself in the future.
Most traders will make a common error after back testing in that they immediately incorporate the strategy with their actual investment plan without first field testing the strategy.
Field testing means testing the strategy in real-time (the actual market). However, the main difference is the use virtual money instead of real funds. This allows you to test the equivalent sum of funds you would use out of your investment accounts without risking it right off the bat.
With field testing, you can test your strategy against a living, breathing market. What you saw work via back testing is now put to the test in real-time and is, usually, when your hypothesis is proven accurate or incorrect.
**Note: There are traders who use real money to field test with; however, the amount used tends to be a much lesser amount.
Advantages of Field Testing
- The number one advantage is that you get to test your strategy in real time without risking real money.
- You get to test your back testing hypothesis against a living, breathing market, which will tend to act differently in many respects, as compared to past performance metrics.l money.
Disadvantages of Field Testing
- Just like with back testing, it can breed a false sense of confidence in how the market is going to react once you start using your money. (History very seldom repeats itself exactly).
- The tendency to not approach it like you would if you were using your actual money. The point of field testing is to execute the strategy as if your money were on the line. However, many traders have admitted to approaching field testing without the proper focus, due to it being virtual money. Often resulting in you not being ready when you incorporate the strategy using your funds.
Before ending this article, let me leave you with one final important message in regards to using testing methods: while back testing and field testing are both excellent tools for testing and fine-tuning any spread betting strategy, you must always keep in mind that they are just tools. It is ultimately up to you how the tools get used.
Before you start even testing your strategies, you should make sure you understand how financial spread betting works and how to choose spread betting company which will work for you.
The following article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.