I recently received a questions via email from one of my readers about backtesting day trading strategies and the proper length of time that one should test before implementing them. I felt would be better addressed in a post so others could learn and hopefully contribute to the dialogue, any of their experiences regarding this matter. I’ll answer this based on my experiences as best I can.

Oddly, my questions don’t have much to do with analysis, it has more to do with psychology and readiness. I am an Optionetics student (Options trading education), and went to one of those “free seminars” about 2 years ago. They are good at teaching fundamentals, and even providing some trading ideas to get started.My questions are related to how much back and virtual testing is enough? I have 1 system, but it’s taking months to test it. Does this sound normal?

I’m almost always testing some sort of scan or strategy because I like that mad-scientist approach where I can express my creativity within this trading world. I can say that most of my indicators, chart patterns, and thought processes are far outside of the norm and I want it to stay that way to capitalize on being different than the crowd. I’ve been fortunate to have lived through the 98′ blow off market top and the 08′ meltdown so I’ve seen most of what the market can throw at us investors. This brings me to one of the first things you have to do when testing a pure market timing strategy

1. Which side of the market are you playing, and more importantly, where has the market been lately relative to the longer term. You would never test a long strategy during a phase of market contraction. Also, your results would most definitely be different if your backtesting took place at the beginning of a bull market vs. the latter stages of one. This is one of the reasons I have an issue with backtesting different strategies without being aware of the type of markets, as the circumstances are never the same for comparisons sake therefore it’s quite difficult to trust backtesting results.
2. Is the system one for the general markets or is it targeting a certain setup for individual long/short opportunities? These two types of trading are significantly different and require a different approach regarding the reaction time to enter the trade. It’s not as simple as finding a long strategy that works and then reverse engineering it for a shorting screen because in my experience that rarely, if ever works. When shorting you are capitalizing on fear and that behaves completely different than hope/optimism (long trade) and requires you to be quicker on the trade trigger and have a shorter trade expectancy.
3. Develop, implement, and strictly follow mechanical rules for entries and exits for when you’re cutting losses and taking profits. Know exactly what you are going to do ahead of time so you’re not changing your approach mid way through. There is no room for being a discretionary trader when testing a strategy because then you’ll have nothing to test future results against.
4. If you are testing a market strategy for going bullish/bearish I would give it 2 complete cycles of the markets being bullish and bearish, and that would be by whatever indicators  you determine a bull/bear market to be identified as. If you are testing a bullish strategy for a certain chart pattern, I would give it at least 2 bullish cycles to test and make sure it works in different bullish up cycles. The same goes for bear strategies. This could take anywhere from 3-6 months depending on how volatile the markets are.
5. Start with a small percentage of your capital when you feel you have done the appropriate amount of research and increase as you have success. It’s almost inevitable that your results with real money vs testing money are going to be different because you’ve introduced emotions into the mix, but be mindful of any variation in your trading and correct it as you go. This is a very important step because if you start off on a losing streak your first inclination may be to scrap the whole system you’ve worked on for months, but this is the reason why you start out with a small position size. Give your system time to play itself out. A core Turtles axiom regarding this is:

Judge yourself not by the outcome, but by your process.

This list is my no mean all inclusive of what goes into testing a trading strategy, but it’s a start. If after posting this I feel like there is something more I want to add I’ll revise it, or maybe a comment by one of my readers will spark my memory but there’s no point in holding this post because I may have forgotten something.

Photo courtesy of…

I didn’t have any new stocks show up on my regular scans so I checked out my Canadian scans and found these 4 gems. This market seems to be overheating, but after a healthy pullback these could be a few to keep your eyes on. There could be another ATC.V in here. I found it at $2.40 and it’s over $7 now. Another 20% today! These are the kinds of fish that get away and they haunt you for years…lol

Everything about today was normal and I picked up SPRD and CTIM on their pullbacks. No idea where we go tomorrow but I’ll be looking to add a few other longs in my watchlist.

Maybe this won’t play out the way I’d like it to, but I’d prefer more of a pullback before opening a position in TLT, say back to it’s 50ma. Given that today’s gap up 2% rally was on weakened volume it still could make it’s way down to that important moving average. The RSI is still in bull mode and could support a move down near 100 before I’d start to get worried about a new downtrend starting.

All this talk about the death of bonds is nonsense at this point given how bullish this chart is. That could change is the chart undergoes significant technical damage, but at this point that is not the case.

I’ve been drawn to some of the more speculative momentum plays in the junior mining companies when I start to see many breakout plays like these showing up on my scans. Some of my recent suggestions in the Canadian markets have scored 30-50% gains  this past week alone and if the $TSX can breakout of into multi year highs it looks like this area could be a great area to focus more attention to.

The one hurdle that this index faces is it may have gone too far too fast and need some time to consolidate for a few weeks to maybe a month before breaking out to new yearly highs. But it doesn’t take a technician to see which of these two markets you should be focusing more attention on. Another point to consider is if the gold market has a pullback (which I have a feeling there is far too much bullishness in this area) that could pressure the $TSX as well.

These plays are starting to look a little frothy, and it will be important to see how they behave when they give back some of their gains. I would add some of the below stocks to your watchlist and monitor them for good entries.

http://screencast.com/t/NDhiZTQ2ZDI (copy and paste into browser)

As my market timing system goes bullish, it’s time we switch our focus towards momentum stocks that will be the leaders of this upturn. I sold out of my remaining short etf’s yesterday after the close and will be doing research this weekend to identify some great long plays with excellent risk/reward. While I remain unconvinced that the market has any firepower left after 3 huge days of up moves, I will trade only from the long side until we get another down confirmation. Any trend system will give back a portion of their gains when the trend changes. Below is a quote from The Turtle Traders.

“The trend follower disciplines his thoughts into a strict set of conditions for entering and exiting the market and acts on those rules or his system to the exclusion of all other market factors. This removes, hopefully, emotional judgemental influences from individual market decisions.”  ~Barbara Dixon

GMCR has been a solid leader for the last 2 years and a IBD darling. Wait for breakout.

VHC showed up on my screens Thursday and just screamed higher Friday providing no entry. Massive volume leading this higher, I’d be a buyer near the 10ema.

ROVI has been a 4-bagger since the 08′ bottom and it’s starting to get towards the area where BO’s could fail. Each subsequent base has been shorter in length and that’s not really a good thing. This BO would have to be perfect with price/volume action.

GTE - volume has been high and this one has a certain “look” to it. Plus it’s Canadian!

…but the upside is you may feel inspired as well.

I’m a huge fan of Eddie Izzard’s comedic performances (Dress to Kill), and he’s a very talented actor as well (Circus, Shadow of the Vampire), but what he accomplished recently is almost unbelievable. Maria and I went to see him 6 wks ago when he was in Vancouver and while we were there we were talking to a nearby fan, and they told us how 1100 miles for charity. That equates to a marathon a day, 6 days a week, for 8 weeks.

Now I thought we were informed about what Eddie’s been up to but clearly we had fell behind and I highly recommend this documentary on his journey he accomplished last summer.

Here is a quick interview on GMTV after completing his 10th marathon. If you’re new to Eddie’s material, I would start with Dress to Kill

We’re all different, but we’re all the same. ~Eddie Izzard

It’s do or die tomorrow for my day trading signal. A positive close and I’ll be closing my short positions, but it’s not in the bag for the bulls either with an important macro news event that could sabotage this rally.

This chart looks even better on a 2yr wkly as it’s completed the cup/handle round trip with a breakout to top it all off. Earnings juice has fueled the move and it should be a winner with these technicals. Now if it’d just pull back for us to all pile in everything would be perfect.

I mentioned yesterday here on twitter that the markets seemed like they were gearing up for a big move. I just had the direction wrong and never thought Obama could move that many people to jump back in the markets, but it is what it is. Oh, and I also included my twitter feed on my site (right sidebar near the middle) for those who haven’t embraced that technology yet, so you can see what I see when I don’t have the time to do a blog post.

Anyhow, before I talked about the markets, click on the chart ATC. I mentioned this stock 3 days ago and it’s up over 50% today. That is unreal. I think I’m going to start focusing more time on Canadian equities because lately I’ve been huge % gains on those stocks that have been showing up on my scans. Tell me that one of you out there was smarter than I and picked up some shares of ATC….

Back to the general markets. Huge day with volume accumulation that can’t be ignored, but it’s still too early to tell if this will lead to something more than a small bounce. The last time the Nasdaq had this much up volume in May, it resulted in nothing more than a small bounce. The pressure is on the bulls to keep this market moving higher and there is a lot of resistance along the way.

One thing that really surprised me is that my timing system barely budged today. Sure, it improved, but it was closer to a buy signal last Friday than it was after the close today. I basically spent the day away from my desk because it was obvious we were going to close near the highs and I didn’t want to get persuaded by my emotions into doing something outside my trade plan. My scans aren’t showing quality breakouts at this point and that is one reason I’m suspect of today’s move.

The bottom line is that until we get a buy signal on my timing system, I’m going to continue to hold my reduced short positions.

Update: For those who want to get the book Mark talks about in this interview, go to the comments section of this post.

Howard Lindzon interviews one of the market wizards, Mark Minervini. Howard asks all the right questions and there is a lot of great advice and insights packed into 33 minutes. After listening, Mark reminds me of one of the turtle traders in how he approaches the markets, reminding us that (much of the time trading is boring and a lot of sitting on your hands).