Hello stink,
While I wouldn’t want to dissuade you from embarking on a “mechanical/back testing” path if this is your preference, (and you believe this is the direction you want to go in), it may be worth taking a step back conceptually to consider alternative paradigms including analysis styles, and trading psychology, or at least consciously recognise this choice.
Here’s what I’m on about –anyone involved in the market has a tendency to impose their perspective/bias on the limited information they have access too in their analysis. Hence understanding your own bias can be a subtle yet critical element right from the core strategic approach to investing/trading.
So, going down the mechanical/back testing route in effect excludes a whole range of alternative approaches. Many that do this have not considered the trade off they are making. Certainly if you are convinced this is the best approach for you, please, by all means proceed with confidence, people like tech/a have demonstrated that this approach can work consistently and effectively (I stress “can”).
Here’s my controversial perspective on technical analysis: I think that oscillators/moving averages actually obscure the individual’s capacity to really perceive the way markets trend. I would argue that by focussing on formulas and algorithms that a trader becomes reliant on automation, and may cease to really study charts and how markets trade.
I also think that there are discernable market patterns through the ages, and looking at interrelated markets (e.g. currencies and related commodities/indexes) is vital to developing a holistic approach to investment/trading.
My understanding of the back testing regime is that you are assuming that if you run enough numbers through a select piece of history, that this scenario of the past can be usefully extrapolated into the future, and that a positive expectancy result can be achieved by incorporating an algorithm into a mechanical system telling you where to enter and where to exit.
This approach does have merit, and can be quite effective in certain market conditions, particularly in a sustained trending market. Also, if you do go down this path exclusively, mit’s suggestion not to “curve fit” is excellent advice.
There are tradeoffs adopting the mechanical/back test style though. In a way a trader going down this path is surrendering their own inherent direct analytical skills to a “black box (although the better mechanical people at least understand what is in the “black box”).
The problem I see is that the approach is only as good as the backward oriented analysis of a time in the past, and if the trader/investor is looking into the future while imposing their bias on the market (either by machine or by limiting their ability to perceive psychologically, or both), then they are resigning themselves to a limited ability to “see” the market. eddievanhalen made an excellent point on another thread which I fully agree with:
Originally posted by eddievanhalen. Thread: Which one do you use? Technical or fundamental analysis. Post:152
the best traders I know are "discretionary" and have a system based upon experience and some concrete principles which cannot be punched into a system tester and "proven" - they are based upon a huge amount of observation , experience and hard work.
I am in agreement with this philosophy.
So I’m suggesting a path where you retain an awareness of these pitfalls, and consider actively seeking out alternative perspectives so that your future development is not cramped (much like in learning music – incorporate the “theory”, but also nurture the ability to “improvise” and create original music).
Hope this is of interest.
Regards
Magdoran