For both beginning and seasoned traders, formulating and executing new strategies can often be challenging or tedious. The two most tried methods for testing new strategies are paper trading and back-testing or simulation. Although both are seemingly for the same purpose, increasing gains, they have very different uses and advantages. A new trader, specifically traders who want to become day traders or scalpers, will often hone their skills with paper trading, rather than back testing. Back testing is used more for automated trading, something an advanced trader or programmer would consider.
Back testing a strategy is more popular with those capable of designing and programming their own strategies. These strategies will then be used to place trades, usually automatically when certain market indicators are in placed or other triggers are set off. Back testing, as the name implies, relies on back or historical data. Historical data is valuable because it is a true reflection of what has happened before, however, that is also its fault. Historical performance testing will reveal how well a strategy would have worked in the past; however, it will not guarantee success in the future. For example, if one is testing a strategy with data from the dot com bubble, one’s results would be skewed because that era was not part of a typical market cycle. It is important to not “cheat” and look ahead at data while back testing, it is also important to know the market environment at that time of the data provided; exceptional circumstances will greatly effect the performance of a strategy.
Paper trading, on the other hand, is a very different way to test trading strategies. It is not exactly a testing method, but more like practice for day trading. Someone who is paper trading in hopes of sharpening his or her trading skills will usually have some strategies already in mind for day trading and scalping. Paper trading allows them to assess their skills using these methods in a real time environment. Day traders will find paper trading very useful in terms of figuring out what time of the day to place their best trades, if market volatility hurts them or helps them and if they are simply quick enough to gain a profit.
It may seem clear to a trader what they want out of performance testing, so back testing or paper trading may be an easy choice for them. However, there are advantages and disadvantages of both. Foremost, the time frames in which these methods occur vary greatly. Paper trading may take a whole day, a week or longer to perfect a strategy, valuable time that can be spent on actually trading. On the other hand, back testing can be used to process years’ worth of data in minutes. While the amount of data tested varies greatly, it does not ensure accuracy in performance. Aside from historical performance testing not telling the future, many simulations do not account for slippage. Conversely, because of the real time nature of paper trading, a trader will experience slippage and other difficulties that can only happen in real time. Also, with paper trading in a real time environment, traders will get a sense of market movements as they occur, without being able to peak ahead at data. With these considerations, choosing which performance testing method is right for you should be simple.
DAS|INC, with the upcoming launch of DAS|BOX, will not only be the complete solution for trading, but also for testing strategies. DAS|Pro already has a paper trading feature. If you currently trade at a firm that utilizes DAS|Pro, you can ask your administrator to set up a training account for you, if you wish to test a new strategy without risking your capital. Now with the upcoming launch of DAS|BOX, you can test various strategies with historical data, provided by DAS|INC, to optimize them before placing trades on the market. DAS|BOX is set to be released this quarter, with numerous features that can be used seamlessly with DAS|Pro. If you are a qualified party interested in testing a beta version of DAS|BOX, please contact us via dastrader.com to obtain a trial version.