crypto strategy

How to backtest your crypto trading strategy

Before you buy a phone, laptop, or anything else, you want to make sure it works by testing it; this same practice should be carried out in commerce. You should not use your trading strategy in the real market without testing if it works or at least having an idea of ​​the results it can give, that is why you must test it.

What is backtesting?

Many new traders go through the cycle of developing a strategy that seems to work, using it for a while, and abandoning it after losing a series of trades. They then look for other strategies and repeat the cycle. As a result, many of them give up trading, thinking that no one can be consistently profitable in the crypto market or that crypto trading is not for them.

So instead of going through the cycle of stopping using one trading strategy and choosing another when you start losing trades, you can test your strategy with data to see how it would have performed over time. time without risking money. A positive result will help you to have more confidence in such a strategy.

Backtesting allows you to assess the potential performance of your crypto trading strategy based on historical data. The idea is that whatever result a strategy produces on historical data is likely to be repeated. Thus, a strategy that performs well by testing it on historical data is likely to perform well in future market conditions and vice versa.

4 reasons why you should backtest your trading strategy

Below are some benefits of backtesting your trading strategy.

1. A zero-risk strategy test

You won’t have to risk your trading capital when backtesting your strategy. Rather than testing your trading strategy on a live trading account, backtesting is an ideal solution.

2. Refine your strategy

Backtesting reveals the strengths and weaknesses of your strategy. Then you can use the information to adjust the strategy to your trading needs and personality type.

3. More confidence in your trading strategy

Backtesting allows you to try different market strategies to choose the best one. This practice will increase your confidence in your strategy, especially if it performs well on a large chunk of market data.

4. Get new ideas

Since the backtesting process exposes you to a lot of data, you are likely to see more repetitive trading patterns, which will yield new trading ideas in the process.

Two ways to backtest your strategy

Backtesting your crypto strategy can be done manually or automatically.

Manual backtesting

Manual backtesting of your strategy will require placing trades on historical data yourself. To perform manual backtesting, you need to follow the following steps.

  1. After opening an account with a reliable crypto exchange, open the chart setup of the desired asset.

  2. Backtesting requires a strategy. You also need to decide which tools and indicators you want to use. For example, your strategy could be to trade trend bounces (bearish or bullish) on BTCUSD within a 1-hour timeframe after the price bounced off the 61.8% level using the Fibonacci retracement. The 61.8% Fibonacci level must also form a confluence with the trendline to validate the move.
  3. Since you now have a strategy, the next thing to do is go back to where you want to start the backtest. In the case of BTCUSD, you can start as early as 2013. You can then look for trends on the 1-hour chart to see the possibility of trend continuation past a retracement that meets your set requirements.
  4. When you see a relevant setup, you should use the tools and indicators you want to test on the chart. In this case, the Fibonacci retracement tool and the trendline. Then plot the chart as you would if you were to trade the move when it initially occurred. After that, move your chart from candlestick to candlestick to see the result. The idea is to slowly advance the chart to see the outcome of the trade and then document the outcome.
  5. As you write the result, you can keep scrolling to get new setups, use your trading tools to analyze them, and move forward to see what happened. Repeat this process until you have browsed a lot of data. Some platforms like TradingView allow you to play and pause historical data automatically, so you won’t have to scroll through it yourself. You can also control the reading speed on the graph. This is available for Pro, Pro+ and Premium users of the platform.

Manual backtesting can help you gain some control over bad trading psychology since you will be emotionally involved to some degree. The method also does not require you to have any coding skills.

On the other hand, manual backtesting is time consuming as you will need to analyze lots of historical data to get your results. It’s also easy to make mistakes when tracking your past data or results. Manual backtesting also becomes more tedious if you try to evaluate multiple timeframes.

Automated backtesting

This method of backtesting helps you use technology to test if your strategy is working, typically using coding to streamline the process. It allows you to test your strategies easily and faster over a long period. You can then use the data generated to find out if your strategy is adequate and what needs to be adjusted.

Automated backtesting works the same way as manual backtesting. You will also need to choose a time frame, your trading asset and the strategy to test. The main difference is that you won’t have to set up every process, write down every order, and calculate the profit and loss yourself – they’re all done automatically.

The main challenge with automated backtesting is that you may need to know how to code or at least have easy access to coding experts.

Disadvantages of backtesting your strategy

While it’s always worth testing your crypto trading strategy, there are a few downsides.

Past success does not guarantee future results

Adjusting and refining your strategy based on the results of historical data can affect its effectiveness. Market conditions are constantly changing. Therefore, a strategy that worked well in the past may not work well in the future. It is also possible that the historical data you are using is characterized by many adverse market events, negative and positive sentiments, etc.

For example, market conditions during the 2020 pandemic lockdown may not represent regular market conditions, and results obtained from this data may not be a good representation of market conditions in the future.

The crypto market is still new

The crypto market is relatively new and some tokens don’t have enough data to test your strategy. For example, consider Shiba Inu; you can only access end of 2020 charts and data, which may not be enough to conclude a definite pattern.

The crypto market is also young and volatile, making it difficult to spot accurate patterns like in the forex and stock markets. To a large extent, the price of Bitcoin still greatly affects the price of many other cryptocurrencies.

3 Important Tips for Crypto Backtesting

The following tips will help you when testing your strategy.

1. Don’t be selective with data

Be sure to use random data sets, not just sets that seem to favor your strategy. You shouldn’t go wrong by only using past data that makes your strategies look good. This practice will only fail you when using real-time data.

2. Be thorough

There is no need to rush. Being thorough will help you spot flaws that causal backtesting might have missed. Leave no stone unturned. To be thorough, you need to use as much data as possible to see how your strategy works in different market situations.

3. You will never have a perfect strategy

All strategies have their flaws or times when they experience losing streaks. All you want to make sure is that the trading style you use will be profitable in the long run and deliver the desired result. You will also need to employ certain risk management practices to achieve this.

Choose your backtesting style

Backtesting can help your crypto trading strategy when you execute it correctly. To determine which is better between manual backtesting and automated backtesting, you need to consider different factors like how much time you have to backtest, your personality, etc.

Manual backtesting can be time consuming and can also lead to errors. On the other hand, automated backtesting is less cumbersome but requires the technical know-how to create it or access to experts who can create the required software. Nevertheless, both backtesting methods have proven reliable in many financial markets.

The information on this website does not constitute financial advice, investment advice or trading advice, and should not be relied upon as such. MakeUseOf does not give advice on trading or investment matters and does not advise buying or selling any particular cryptocurrency. Always perform your own due diligence and consult a licensed financial adviser for investment advice.

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