Four Common Errors In Testing Trading Systems by Thomas A. Meyers
The author of The Technical Analysis Course debuts as a Stocks & Commodities writer with this article. Here, Thomas Meyers explains that mistakes made in systems testing can make the difference between the accurate assessment of a system's profitability and a distorted picture that failed to take into account certain inevitable factors. Meyers shows you how to fine tune your testing techniques so that these problems can't cost you all your trading capital when you go to trade in real time.
A trading system is a set of rules that can be used to generate specific buy and sell signals. For
example, a simple trading system can be based on a moving average crossover. You buy when prices rise
from below to above the moving average line and sell when prices drop from above to below the moving
average line. For short positions, you do just the opposite. You sell short when prices decline from above
to below the moving average line and cover the short sale when prices move from below to above the
moving average line.
More complex trading systems can be developed using multiple moving averages, oscillators, stochastics,
relative strength index, moving average convergence/divergence (MACD) or numerous other technical
analysis techniques, either by themselves or in combination. A variety of price and time filters can also be
used to enhance the reliability of signals and stop-loss rules can be incorporated to control losses.