Last update: August 2021
Tonight’s Show: Backtesting Trading Systems Part 2 with Coach Tyler Craig, CMT
Join us for tonight’s Cash Flow Club: Chartered Market Technician, Tyler Craig will host today’s session titled “Backtesting. You can do it, put your back into it!” Tyler will illustrate how he uses ThinkorSwim’s ThinkBack® tool to backtest trading systems. You’ll learn how to plot the equity curve of your system under varying market environments to discover exactly how your rules would have performed. Bring your backtesting questions and prepare for enlightenment!
Important Note!
** In backtesting, past performance is no guarantee of future results. **
Watch the Replay
If you missed last night’s show or you would like to watch it again, check it out on the player below (PRO Members Only).
Notes from the last week’s show (Backtesting Part 1)
Build the rules of your Naked put system
Step #1 Security Selection
- Pick a stock/ETF that I think I can make money on selling puts over time. And I want test to see if it would have worked over the past 6 months, 1 year, 3 years, whatever!
- If I use a stock – then I have to deal with earnings every quarter
- If I pick an ETF – then there are no earnings!
- USO
- XME
Step #2: Entry
- Date: Every 45 days
- Strike: Sell a delta closest to 0.20
- ALWAYS on approach. I want to passively sell puts EVERY SINGLE MONTH on USO
- Why? B/c I think it will rise over time and systematically selling puts will generate better returns than buy and hold (hypothesis)
- When I’m 45 days out I will look at the trend. Only sell the put if we’re above the 50-day moving average (filter)
Step #3: Exit
- Ride to expiry and let put expire if it’s OTM.
- If ITM at expiry, buy to close the put to avoid assignment.
Metrics worth Measuring
- Number of wins
- Number of losses
- Win/Loss ratio
- Average dollar gain
- Average dollar loss
- Biggest loss
One of the biggest mistakes is to have a good system but bet so much that you give up on a bad month.
Notes from the this week’s show (Backtesting Part 2)
Purpose of Backtesting
To determine if this strategy (set of rules) makes money over time.
If YES – investigate further.
Assume our system deploys $900 every month. Max Adverse Excursion (biggest loss) over the 5 years of backtesting was $630 (63% of your invested capital). That’s big league! That’s bigly.
Position Sizing: I have to do the right amount of contracts so I don’t blow up! So I don’t give up when the chips are down and quit. The only way to guarantee I get what the system is designed to give is by staying the course!
Example: $10K account
- Sell bull put for 50 cents
- Sell bear call 50 cents.
- Take profits at 5/10 cents or ride to expiration.
- Stop Loss = exit at short strike
- 5 Condors (5 contracts) every month
- Typical winning trade: $100 x 5 = $500
- 5% return on total account value 😊
- Typical losing trade: $350 x 5 = $1,750
- 17.5% loss of total account value
- Can you stomach that? Seeing your account drop 17.5% on one losing month.
- Think about worst case scenario. In the backtest we lost 2 months in a row.
- Oh Crap Month: $700 x $5 = $3,500 or 35% of your total account value.
- 5 Condors (5 contracts) every month
TAKEAWAY: I want to do a small enough contract size so I can withstand both losing months and losing streaks. If I don’t, I will give up when the chips are down and not be there when favorable markets return!
If NO – stop and go back to the drawing board!
- With USO we had to modify the strategy (selling puts every month wasn’t great). Maybe I sell calls or strangles or do a trend-following. Sell puts when > 50 MA, sell calls when < 50 MA
- I want to stick with naked puts, I just need a better underlying – maybe EEM instead of USO?
True, BUT it’s the best data we have. If I backtested the system overbullish/bearish/neutral environments, that’s a pretty good sample. If I didn’t make any money in the past with this system, why bother with it going forward?
Backtest legging in
60 days to expiration, if RUT is above 50 MA, sell bull put first. If below 50 MA sell bear call first.
Rule for when you add the other side. What do you do if wrong?
Hedge
Add to winning side (add extra bull put or bear call on the break of support/resistance).
Backtesting Series [FREE Articles]
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- Baby Got Backtesting Part 2 – How to Backtest?
- Baby Got Backtesting Part 3 – Backtesting Execution
- Cash Flow Club: Backtesting Trading Systems Part 1
- Cash Flow Club: Backtesting Trading Systems Part 2
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These and many other questions have been already answered in our extensive pool of articles on backtesting.
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Financial freedom is a journey
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