May 12, 2009 at 7:17 am | | Comments 1

Testing 1-2-3

I’ve written before about my opinion of backtesting, but let’s go a different direction here and talk about just plain-Jane testing.

If you were told that a diet pill would have you in that beach body by June, you’d probably be skeptical.  But given enough evidence, you just might try it.  Tentatively.

We’re no different in our trading.  Those of us who trade daily, who observe the price action and who are truly students of the market will on a regular basis run across something of interest.  Maybe it’s a routine in the overall market (such as early strength or late-day weakness) that seems to provide an opportunity.  Or perhaps it’s a setup that’s been producing some phenomenal moves.

Whatever ‘it’ happens to be, the odds are that you’re initially intrigued by it but yet reluctant to really go for it and trust it.

Why that is, I don’t know.  Human nature I suppose.  But regardless, when we do identify that anomoly which could quickly prove profitable for us as traders, we have to find out if it’s legit.

Enter: the test.

Let’s suppose your standard trade size is, oh, 1000 shares.  Or maybe it’s $20,000 per position.  However you define your standard position size, throw that out the window when it comes to testing a brand new trade idea.

Because the first time you do it, even the 5th time you do it, it’s not about making money.  It’s all about gaining some insights into how that idea plays out.  It’s about getting a feel for how it acts.  It’s about building a little confidence in that setup before you go for it for realz.

So cut that size down by, oh…90%.  I’m saying take 10% of your standard size and give that trade a shot.

Trade it so small that you won’t feel it – win or lose.  Because remember, the point is to start getting a feel for how it might go.  Removing the risk we all feel which is tied to performance is crucial in the testing phase, so that’s a necessity.  Trade tiny and see what happens.

As you start to gather a little data and see some ways you might improve on entry, exit, or timing, then you’re getting closer.  And again, you most likely haven’t made or lost much at all during this test process – because that isn’t the point.  Just feel it out, evaluate the info which comes back to you, and adjust.

Then, once you’ve got it down and have developed a more sound methodology for putting on and taking off that trade, only then is it time to step up the size.  And then have at it, because that’s the point at which it’s about making money.

Anything prior to that is merely a test.

Jeff White
President, The Stock Bandit, Inc.
Swing Trading & Day Trading Service

[tags]Stock Market, Day Trading, Stock Trading, Investing, Swing Trading[/tags]


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