Backtesting is valuable for system design, as well as getting emotionally prepared for what’s possible.
It shows you what your gains and losses would have been had you followed your rules over the previous time period that you’re testing.
There are more things to measure besides gains, losses, and drawdowns.
For all the trades that you make, you’ll have commissions and fees that you can calculate given what of your trades get filled. There is no cost for entering stop orders.
If your backtest generated $60k for last year, but you didn’t consider the effect of commissions and fees, you might be surprised to find that you also generated $40k in commissions. Therefore, your net trading profits are $20k – a big difference than $60k.
Worse, you don’t typically get filled at the price you entered in your order. Stop orders become market orders once elected. That means “you get in line” for the next fill based upon “Priority, precedence, and parity.”
The difference in the price that you entered in your order and the fill price is called “slippage” or “skid” and it comes as a cost to trading. You can add a number to your simulator to represent the slippage in your trading simulations that will represent the impact it will have on your trading and your P&L. This will give you a truer sense of what you’re endeavoring to do as a trader.
Therefore, I’m concluding that when you overtrade, you’re getting the worst of it: you’re losing money, paying higher commissions, and losing money from slippage. That all comes out of your account and goes against your performance.
When try to overtrade your way out of a drawdown because you feel more frequent trading means more opportunity to win, you make a bad situation worse.
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