Backtesting Mechanical Trading Systems for CFD Trading

A profitable system is a very important to have in CFD trading, it is especially more important since this trading derivative involves leverage. It is important to do some backtesting of your mechanical trading system considering you are staking your precious capital.

A good CFD trading system provides indicators that your system can perform even in previous market conditions and based on that we can make an assumption of how it will perform in future trades. Though we shall never be able to make accurate prediction of future performance of a trading system, backtesting it regardless of whether it is manual or through trading software like Trade Station, MetaStock, WealthLab, TradeSim, Amibroker or some other software can help us to gather scores of vital information. This can help us to understand whether a particular CFD trading system is profitable or not, if it is profitable, whether it is consistent and a number of other parameters as well. This is very much important in the procedure of a system trader.

Welcome the CFD System Trader

Trader who trades a specific trading system is called a system trader. A very common kind of system trading is trading with a kind of system that has 100% mechanical rules. Which means the trading rules can be quantified and coded onto trading software so that this can be backtested to evaluate its performance. In a complete mechanical system, the trading rules are not discretionary.

Using trading systems has helped a large number of traders to upgrade their performance in the market who used to lose money before using one. A trading system refers to the one that has been proven to be profitable when backtested. After a CFD trading system is developed, it takes the shortest period of time to trade naturally due to the fact that they do not use discretion or manual procedure to evaluate the market condition, thus avoids burn out and strain. After it is designed, all a trading system needs to do is execute the trades and monitor the performance once in a while to ensure that the system is working according to the expectations.

A mechanical system trader follows three principles:

1. Instead of being a discretionary trader, they want to be a system trader.
2. They execute their trades based on a profitable trading system.
3. They are capable of following the system.

However, it is important that you are capable enough to observe the performance of your trading system since it may perform in a different way based on changed market conditions.
The second principle of a system trader is based on the fact that a system trader believes that his/her system will perform in the same way that it did in the past. If a trader doesn’t follow any of these principles, like not having the desire to become system trader, not having any confidence over the system as he didn’t go through enough backtesting to ensure that the system is profitable or if fails to follow the system and alter the rules as while moving on, then the system will collapse.

In case if a system fails to perform profitably, then the trader should discontinue using it until the whole system is reviewed. Some depends on the fact that drawdown of a system is way bigger than the historical drawdown (however there is a possibility that it will move up after the drawdown is over). For instance, a trading system may fail to perform or suit well in the market if the market condition gets altered significantly.

Limitations of Backtesting Your Mechanical Trading System

Despite backtesting is proven to be an essential tool for a CFD trader, it does have some limitations. The major limitation is that past performance of a system in the market condition does not necessarily ensure that it will perform in the same way for future trades.

However, despite these limitations, backtesting your trading system can help CFD traders in multiple ways:

1. Through backtesting a trading system, a trader can have a good idea about different aspects of the system which includes profit loss ratios, consistency, profitability, maximum drawdown; win loss ratios, average profit/loss per trade (expectation) and so on.
2. Backtesting helps a trader to determine which trading system is the best one in terms of profitability, drawdown, steadiness and all the other performance indicators of a trading system. Thus a trader can test multiple trading systems and choose the most profitable one out of them.
3. It helps the traders to be more confident about trading a system since they can have a good idea about the performance of the system depending on its profitability on past data.
4. Backtesting helps to trade a system with much less time and a require to continuously think and use discretion when trading.
5. Backtesting allows the traders to acquire a valuable skill that they can take with them to reuse in future. If the trader needs to develop a different system in future in order to expand the systems that they’re trading and to generate more profits, then they can easily go for it. Whenever they need or want, they can develop a new system. If you have a list of prospective CFD brokers or providers in hand, or a range of them in mind, then it will be wise to backtest with their existing CFDs and transaction costs.