Backtesting only works with robots? is a misconception that limits traders’ understanding of backtesting’s broader applicability. While automated trading systems (robots or Expert Advisors) are often associated with backtesting, this important process is not exclusive to algorithmic trading. In fact, backtesting is a valuable tool for traders of all kinds — whether they are using manual or automated strategies. This article explores why backtesting is beneficial for both discretionary (manual) and algorithmic traders and why it’s essential for improving your trading approach, regardless of the method you use.

What is Backtesting?

Backtesting is the process of testing a trading strategy using historical market data to see how it would have performed in the past. By doing this, traders can assess the viability of their strategy without risking real capital. In essence, it allows you to simulate how your strategy would have fared under past market conditions.

While backtesting is often associated with algorithmic or robotic trading systems, it can be equally effective for manual (discretionary) traders. The primary difference is that robots execute the trades automatically, while manual traders have to execute them themselves based on the signals or rules defined in the backtest.

Why Backtesting Works for Manual Traders

Even if you’re trading manually and not using an automated system, backtesting can still be extremely valuable. Here’s why:

1. Provides Data-Driven Insights
Manual traders can use backtesting to gather data and identify trends that may be hard to spot through intuition alone. Backtesting allows you to measure the effectiveness of your strategy over time and under various market conditions. This data-driven approach can improve your decision-making and help you refine your strategy.

2. Identifying Patterns and Repetitive Behaviours
Backtesting helps manual traders spot recurring patterns in the market that they can take advantage of. By reviewing past trades and outcomes, you can determine which setups and strategies produce the best results. This is essential for improving your trading skills, as you’ll learn to focus on the most profitable setups.

3. Improving Risk Management
Risk management is an essential part of any trading strategy. Backtesting allows manual traders to assess the risk/reward ratio, stop-loss levels, and position sizing within a strategy. By testing these parameters on historical data, you can refine your risk management techniques and find the optimal balance for your strategy.

4. Building Confidence in Your Strategy
For manual traders, backtesting can boost confidence in their trading strategy. By seeing how a particular strategy would have performed historically, you gain assurance that your approach has the potential to work. It also helps you identify any weaknesses or areas of improvement before applying the strategy in live markets.

Why Backtesting Works for Algorithmic (Robot) Traders

Backtesting is especially associated with algorithmic trading because it allows traders to test their automated strategies using historical data to see how they would have performed without human intervention. Here’s why backtesting is crucial for algorithmic traders:

1. Validating Automated Strategies
Robots are programmed to execute trades automatically based on specific criteria. However, before deploying a trading bot in live markets, it’s essential to backtest the strategy to ensure its effectiveness. Backtesting provides a way to evaluate the bot’s performance and identify potential issues, such as poor risk management or incorrect execution logic, before real money is risked.

2. Ensuring Strategy Optimization
Algorithms need to be optimised and adjusted based on performance. Backtesting allows algorithmic traders to identify which parameters in the strategy yield the best results. This includes adjusting indicators, trade entry and exit rules, and position sizes. By backtesting the algorithm across different market conditions, traders can ensure that the bot performs consistently well.

3. Eliminating Human Error
One of the main advantages of using robots for trading is the elimination of human emotions and errors. A backtest provides a controlled environment to test the automated system’s rules under a variety of conditions, ensuring that the robot is capable of executing trades according to predefined rules, regardless of market emotions or external factors.

Manual and Algorithmic Traders Can Benefit from Backtesting

Backtesting is beneficial for both manual and automated traders, but the methods differ slightly. Here’s how both types of traders can effectively use backtesting:

1. Manual Traders and Backtesting
Manual traders typically backtest strategies manually by reviewing historical charts or using backtesting software. They might use tools like TradingView or MetaTrader to assess past performance, record their trade entries, and adjust their strategies. Manual traders can benefit from a backtesting journal to track the results of different strategies, noting things like entry points, exits, risk/reward, and the reason behind each trade.

2. Algorithmic Traders and Backtesting
Algorithmic traders use backtesting software to test their strategies on historical data, often using platforms like MetaTrader, NinjaTrader, or proprietary platforms that allow them to code their strategies and automatically test them. These traders will input the rules into the system, and the software will execute trades based on those rules to simulate real-world conditions.

The Key Differences: Manual vs. Algorithmic Backtesting

1. Execution

• Manual traders rely on their own analysis to select trades during backtesting and make decisions based on historical data.
• Algorithmic traders test their strategies using automated systems that simulate trades based on pre-programmed criteria.

2. Time Efficiency

• Manual backtesting can be time-consuming, especially for strategies that require reviewing long periods of historical data.
• Algorithmic backtesting is faster, as the system can execute trades automatically based on predefined rules, making it easier to test a large number of trades over an extended period.

3. Complexity

• Manual backtesting involves more hands-on work and interpretation of data, which can be beneficial for honing personal skills and understanding the intricacies of a strategy.
• Algorithmic backtesting provides a more systematic approach to strategy testing, allowing traders to test complex strategies without needing to monitor every trade manually.

Conclusion

Backtesting only works with robots? This is a misconception. Backtesting is an essential tool for both manual and algorithmic traders. While it’s often associated with automated trading systems, manual traders can also benefit greatly from backtesting by testing their strategies with historical data, improving risk management, and building confidence. Whether you trade manually or use robots, backtesting allows you to validate and refine your trading strategies, ensuring that you’re well-prepared before trading with real capital.

Learn how to conduct effective backtests, optimise your trading strategies, and improve your trading skills with our expert-led Trading Courses designed for traders who want to maximise their chances of long-term success.