Speculating the future direction of the financial markets is one of the most often used binary options strategy by traders and investors. There are various number of tools to investors to determine a good binary options strategy, if not exactly then at least give a rough idea on where the future prices might be located in the chart.
Technical analysis, statistical models, or even fundamental analysis are some of the tools that helps the traders to determin the earnings or any economic data that has the potential to change the current trading environment. Given that there are so many tools available at your disposal, the one question that comes to every trader’s mind is the effectiveness of such tools and how much they can benefit the trader to make the right trading decisions.
This is where back testing comes into place and can be used as a credible binary options strategy. Back testing is already in use by professional forex traders can is used for a variety of purposes. From testing strategies to measuring the effectiveness of expert advisors.
What is back testing?
It is a process implemented by traders in order to test a trading strategy on past periods of time. Rather than applying their binary options strategy for the period ahead traders can simulate the relevant past data there by allowing them to gauge the effectiveness of their trading strategy. Examples of trading strategies such as technical-analysis or statistical analysis strategies are most commonly used with back testing.
The bottom line is that if a trading strategy has performed well in the past then the chances of the trading strategy to perform in the real markets is just as high. Likewise, if your trading strategy performed poorly based on past data, then it could have a tendency to perform poorly in the real markets as well.
Back testing your binary options strategy forms a critical aspect for the development of effective trading systems development. Back testing strategy can be accomplished by reconstructing the trades based on historical data by implementing the rules defined by the strategy that is being tested.
A back testing strategy example could be based on the notion that a certain asset tends to move a few points off from its 20 day moving average, not before slipping back to the moving average.
The results from back testing strategy offers statistical data, useful to gauge the accuracy of the strategy that is being tested.
The advantage of using back testing as a binary options strategy is that traders can optimize as well as improve the trading strategies they want to implement. The back testing strategy can help find any statistical anomalies, thus increasing confidence amongst traders in the strategy they wish to make use before applying it to the real markets.
Binary options strategy – Back testing statistics
Back testing a strategy can offer valuable insights into your trading strategies. Some of which are:
- Net Profit or Loss
- Past dates in which testing occurred
- Measuring volatility based on the maximum percentage highs and lows
- Percentage average gain and loss, including the average bars held
- Win – Loss Ratio
- Projected Percentage return during the year
- Risk-adjusted return which is the percentage return as a function of risk
Deciding on a combination of price action or technical indicator forms the basis of the back testing, which is used to determine the probability of a statistical significance. Traders generally make use of the present market conditions as an alternative in order to identify any chart patterns or anomalies. Some software applications are available that have the potential to show the various outcomes of past historical patterns based on a click on the price bar.
Traders must keep a close watch on the wide trends in the markets within the time period for which a given binary options strategy is being tested. As such, if a binary options strategy was back tested in early 2010, it would not perform well in a bearish looking market. Thus it makes for a good practice to back test your strategies over long periods of time that takes into account different market conditions.
Back testing a binary options strategy can lead to a phenomenon known as over optimization or fitting curve. Back testing strategies over a small periods of time, often referred to as fitting curve could create situations where the strategy wouldn’t work over a broader time frame. Under these conditions, the performance results are tuned closely to the past that they lose their accuracy when pitched against the present market conditions.
Implementing rules that apply to all stocks, or a selecting a set of targeted stocks is a good practice as the strategy is not optimized to the extent that the rules of the strategy are no longer understood by the investor
When back testing your binary options strategy, it is important to factor in the specific instrument being used in the processes. As an example, a stock on a regulated stock exchange tests quite differently in comparison to testing an index or even a forex currency pair.
Customizing your back testing is of utmost importance. Many back testing applications have inputs for round (or fractional) lot or tick sizes, commission amounts, requirements for margin, prevailing interest rates and much more. In order to get the most credible results when back testing, it is imperative that the traders fine tune the various settings in order to replicate a live trading environment.
Binary options strategy – Summary
As a parting tip, back testing your binary options strategy is not entirely accurate in terms of measuring the effectiveness of your trading system. Binary options strading strategies that faired well in the past do tend to fail in the present and vice versa. Therefore past performance of your binary options strategy should be a definite indicator for future results. Before taking your binary options strategy live, traders must always ensure to paper trade their strategies that has passed your back testing strategy in order to ensure that your binary options strategy still applies in real time.