You've finally settled on a trading strategy. But how do you know it's actually successful? Well, luckily, there are a few ways. Here are two:
1.) Back-Testing
Back-testing is a method of testing which will run your strategy against prior time periods. Basically, you're performing a simulation: you use your strategy with relevant past data to test its effectiveness. By using the historical data, you're saving a ton of time; if you tried to test your strategy by applying it to the time periods yet to come, it might take you years. The effectiveness of back-testing relies on the theory that what has happened in the past WILL happen again in the future.
2.) Paper Trading
Paper trading is a method of "risk-free" trading. Basically, you set up a dummy account, through which you can test your trading strategy with paper money. There are two methods to this: you can either pretend to buy and sell stocks, bonds, commodities, etc., and keep track of your profits and losses on paper, or you can open an account online, usually through your broker (and usually for free).
This is a fantastic way for traders to kill a whole tree full of birds with one stone. First off, you'll learn the tricks of the trade without putting your own money at risk. Second, you'll be able to gain some much-needed confidence when it comes to maneuvering in the markets. And third, you'll be able to test out your trading strategy in real-time simulation.
This is probably the best way to test a trading strategy, since it doesn't rely on historical data. On the other hand, it's the most time-consuming strategy, since it might take weeks or months until you have enough data for a statistically relevant performance report.
When testing a strategy, keep in mind that markets change.
When back-testing, there are definitely things you need to be aware of. It's not enough to just run a strategy on as much data as possible; it's important to know the underlying market conditions.
Either method of evaluating your strategy will require time and effort, but both will pay off in the long run.
Markus Heitkoetter is a professional day trading coach and the author of "The Complete Guide to Day Trading." Visit http://www.thecompleteguidetodaytrading.com to learn a 7-step approach for developing your own profitable trading strategy.
AP - Global stock markets rebounded strongly on Monday after last week's historic sell-off as governments from Europe to Australia and the U.S. intensified efforts to ease a financial crisis that threatened to the throw the world into recession.
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