Modus Trading

Trade Like the Professionals

Trade Like the Professionals

What is meant by step testing?

When commodity traders evaluate systems to discover their potential, they nearly always need to carry out a large number of tests because most system rules contain what are known as parameters, which are variable values that govern the detailed operation of the rules.

For example, suppose a trader is evaluating the Bollinger Breakout System.

The system uses an envelope consisting of an upper line and a lower line, beyond which the price must move in order to generate a buy or sell signal.

The width of the envelope is related to the volatility of the price during a particular time interval (say, one day). The volatility is expressed as the standard deviation of the closing price for that day.

The trader will want to test how the system would have performed over the most recent, say 5 years - perhaps from the middle of 2001 to the middle of 2006.

The Bollinger Band lines are built onto a moving average line of the closing price and are spaced at a number of standard deviation distances either side of this line.

So there are two ‘parameters’ involved - i.e. the number of days for the moving average calculation and the number of standard deviations to be used.

Suitable settings for these parameters will have to be found by testing, therefore, let’s assume that they will be tested over the following ranges:

Moving average, between 20 and 50 days in daily steps - making a total of 31 steps.

Standard deviation, between 1.0 and 2.5 in steps of 0.1 - making a total of 16 steps.

In all, a total of 496 (31 multiplied by 16) complete time period tests from 2001 to 2006 will be required.

The results of all these tests will be analysed (hopefully with assistance from the trader’s computer!) after which the trader will be able to select parameter settings to enable him to complete the remainder of his evaluation work.

Quite clearly, a considerable volume of work must be done and the most efficient way is if the trader’s software can deal with this automatically. This is done by testing one pair of parameters and then ‘stepping up’ to test the next pair and so on - until all 496 steps have been completed. Summarised tables of results are then produced. This operation is known as step testing.

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