Lesson Overview

Back-Testing Technical Analysis Signals

Traders are stir crazy about technical analysis and using the signals from indicators like MACD to trade. Yet do you really know if the indicator you are using is profitable for the stock you are looking at right now?

In this video tutorial, we'll help you quickly back-test more than 10 years of signals in both SPY and GOOG to see which one actually produces a better profit long-term. The results are incredible and will make you think twice before blindly following another MACD signal again.

More Discussion

Was This Helpful? Add Comments/Questions

Show Video Transcript +

In today's video, I want to go over a technical analysis study and how you can back test all of the signals that you receive from these technical analysis indicators.

As many of you know we use some technical analysis indicators as part of our own trading system, and I know a lot of people use technical analysis indicators, but it can sometimes be hard to know which ones actually work, or which ones don't work.

Today what I wanted to do is just show you real quick what some of these technical analysis signals look like, and then how you can actually back test a lot of these studies.

What I'm going to do here, on my chart on my charts, and we just have a chart up here of the S&P500, and what I just want to show you is just a quick MACD indicator.

Down here below, in the bottom section of the video, you can see we have these MACD 2 lines, which just shows a little bit of divergence and convergence, which generally signals a move in the market.

What you generally look for with a MACD signal is this cross of the faster moving indicator, which is the one in green, to cross above this slower moving indicator which is the one in purple.

Now, when you get this cross, that's a bullish cross, it would basically signal that the market is ready to go higher. You can see that that generally held true through this signal here on the S&P500.

When you get a signal the other way, where the faster term indicator, which is in green, passes below the slower term indicator, which is in purple, you get the [inaudible 00:01:31] again.

It held true here as well as the S&P500, so it's actually been fairly reliable and fairly consistent for the S&P at least for these couple indicators, and signals that we've seen recently.

The big question that I always had is how does this indicator work long term? So one of the ways that we can do that and check ourselves and kind of test out different indicators to see what works on one particular stock versus another is to back test a lot of these strategies.

What you want to do inside your thinkorswim platform is go up here to the 'studies' up here in the top right-hand corner, and so you're just going to click that 'studies' right there, and the first thing we're going to do is we're just going to remove all of the studies that we have on the chart right now.

This just gives us a clean look at the charts. We're going to go back up to 'studies,' and we're going to go down to 'edit studies.'

Now, inside of this 'edit studies' screen,' you can see that there's actually a tab up here for strategies, so instead of adding an actual study, which is MACD and all these lines that we just took a look at, we're actually going to add a whole strategy.

This is going to give us signals that are actually right on the actual chart instead of us having to interpret if it's a buy signal or a sell signal.

It's going to actually generate these signals over the course of the chart that we're looking at. In here what you can do is type in any strategy you want to look at, in this case we'll look at the MACD strategy, and once it pulls up the MACD strategy, you can see that it's already preset for the default strategy inside the system.

What we're going to do is hit 'okay,' and now you can see that this gives us these buy or sell signals basically exactly where we have looked and seen those crosses, but it's already on the chart.

It's showing us these buy and sell signals that are actually on the chart, so this really helps to clean up your charts, you can see the signals on the chart.

Even more so than that, we can actually go back in time the last ten years here for an S&P500, you can see it looks like it's kind of riddled with all these signals, which seems to be okay because the market's always moving, and it has ebbs and flows.

Now what we can do, is just right click on any of these signals, so you can do it on any of this wording here, just right click on them, and just go ahead and right click on them, you'll have the opportunity to go down here and it says. 'show report.'

What this report is going to do is show us all of the signals and tell us whether or not these signals actually generated a profitable return over the past ten years looking at these signals.

When I click 'show report' here, it brings up this nice little report here that says okay from the last ten years, which is basically 4-7 through 3-23, the time we're making this video, here's every single time that we want to open the amount, the price, the time, did we make money or did we lose money, etc, etc, etc.

You go down to the very, very bottom of the report, and you can see that at the end of ten years trading just this MACD exactly how it was set up, you have a total P&L, or profit and loss, of $1,141.

Now, that to me isn't that great, given that you're trading 100 shares of the S&P500, doesn't seem like you made that much money.

You still made money at the end, and the number of trades that you entered was about 425 different trades, so commissions obviously would have taken a lot out of that profit and loss, but that's not counting.

The key here is that this is able to go back in time and actually back test all of this trading data to see, hey does MACD work the way it is right here on the S&P versus Google or Apple or whatever the case is.

So now that you have this actually open, you can just type in any other ticker symbol, so let's type in Google, for example. You can see that the strategy is also prevalent on Google. You can do that same thing.

We can just right-click on any of these wordings, and go down to 'show report.' It's going to give us the aggregate report of our potential profit and loss trading MACD with Google.

Now you can see with Google versus the S&P500, you're total P&L was 31,328, much, much better than if you were to sell MACD on the S&P. This again gives you an idea of which stocks work better with MACD versus don't work as well with MACD or any other strategy that you want to use.

Again, with Google, we had almost 373 different trades, and so that gives you an idea of how many times you're going to be in and out of the security.

One quick thing I want to show you is that you can actually adjust the studies to make them a little bit different and kind of test different parameters.

One thing that we might want to do is test a different length of time between the indicators, so maybe instead of twelve and twenty-six, we might do fifteen and thirty, okay so just a small tweak in the indicator, and we'll see how that result carries over to our actual profit and loss.

You can see that the result carries over, and we actually made a little bit more money just with a very small tweak to how the indicator shows up, so this gives us a little bit more confidence, knowing going forward that we are able to make a lot more money trading MACD on Google than we are with the S&P500.

I hope this video has been helpful. We're actually in the middle of creating a huge, huge case study and report on all of these different signals with a lot of different securities, covering the last fifteen to twenty years and multiple different testing timeframes to see which indicators are the most profitable and most consistent as far as their win rate going back historically.

We'll let you know when that report is available, and as always, happy trading.

eBook Download

The "Ultimate" Options Guide

Ultimate Options Strategy Guide

The step-by-step guide on how to set up each of the top 18+ options strategies we trade to generate monthly income. Read the whole strategy guide in less than 30 mins and have it forever to reference.

Download PDF

Join More Than 47,345 Members

Membership is always free & you can upgrade anytime to unlock our live trades.