Simulating Trading Portfolios by Ajay Jani
Trading commodities? Here are the steps to testing a trading system used for a portfolio of commodities. This article also discusses portfolio-level simulations, variable shift testing and money management.
A great deal of attention has been focused in recent years on the importance of having a thoroughly
back-tested trading system, and for good reason. Only with thorough and conscientious testing can a
trader be assured of trading with a system that is profitable over time. Many software companies have
recently introduced programs that allow the user to input the rules of a trading system and then test the
system over a number of commodities to determine its viability.
There are two purposes for this extensive back-testing. First, and more important, thorough back-testing
can determine if the concepts underlying the trading system are valid. For example, if your system shows
a profit of $30,000 in Treasury bonds but $24,000 of it came from a single trade, then you may want to
think twice before trading T-bonds with this system. A good software package will create a report
detailing the performance of your trading system and include number of trades, percentage of wins, ratio
of wins to losses, largest drawdown, longest drawdown, largest loss, largest profit and so forth. Second,
back-testing can generate confidence in the system being considered. If a user takes several days or even
weeks to carefully analyze the results of his system, he or she will help create the sense of confidence
necessary to successfully trade it in real time. In a sense, the discipline of testing the trading system
should help foster the discipline necessary to trade.