After you have found a profitable trading system that you already
back-tested, how can you be sure that this system will produce the same
gains in future?
Nobody can predict the future, your system can easily make losses in next years or can be no tradable.
There are some tests you must do before accepting a trading system,
these tests swill show the robustness of your system and when passing
these tests, it will be more likely to show gain in future.
Test 1 : Make sure that you put liquidity rule, that your entry and exit prices are realizable.
Test 2: Examine again your trading systems and your rules (This is very important).
I made dozen of trading systems that showed great results but after
more examination, it showed that i cannot follow them in real life.
Check if there is one stock that made very big gain, the system will maybe become no profitable without this stock.
Test 3: Change twice or 3 times the date of begin for the simulation,
if it still show good results then it has passed the test 3.
Test 4: Change values of some parameters or variables you have in your
trading system rules, you must change one value and then back-test,
change another and then back-test...
If the results are not affected very badly then it passed the test 4.
Test 5: Try to restrict the system from buying 20% or more of stocks
you previously bought when doing the back-test. Then re-run the
back-test. To pass this test, system must show pretty the same results
as before.
Test 6: Equity chart must have a good look, check some statistic values
like sharpe ratio, sortino ratio, standard deviation, maximum drawdown,
average day for gains recovery...
It depends on the risk you are willing to take but choose only systems
that have : higher sharpe ratio, higher sortino ratio, lower standard
deviation, lower maximum drawdown...
Exclude systems that have very big max drawdown, standard deviation and average day for gains recovery.
The must important factor i think is average day for gains recovery.
Its the average number of day that you must wait until your equity
value will goes back to the same level before the drawdown happen.
Big values will let you wait for long times before recovering gains and
for sure many traders will abandon their trading system, and that's the
worse thing that can happen to a trader because just after that, the
system will show excellent results. (That's always happen)
Theses tests are very restrictive and you will reject maybe all your
trading systems, but when trading you will put your money, real money,
so i think you must be very selective to make all chance in your side.
