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Paper Trading & Analyzing Strategy

Having crafted and executed options strategies, the next step is to analyze their performance and identify areas for improvement. This section will delve into strategy testing and performance analysis.

Strategy Testing

Before risking real capital, using the forward testing capabilities of your strategy builder is paramount. Here's how to grasp this feature and interpret the results:

How to Forward Test Using Strategy Builder

Follow the below steps to Forward Test using Strategy Builder:-

Step 1- Sign up for a free account on Algotest's website, then log in.

Step 2. As shown in the image below, click on "Strategy Builder"

Step 3. An interface similar to the one below will appear.

Step 4. Next, add the legs from the option chain that you want to use for the strategy you want to create. For example, if we want to build an iron fly, we would sell ATM CE and ATM PE and buy OTM CE and OTM PE from the option chain, like in the image below.

Step 5. Analyze your strategy using the different tools provided by AlgoTest.

  • The Strategy Builder lets you analyze your investment plan by showing you how much money you could win or lose, what the best and worst outcomes are, and where you might break even. A payoff graph is especially helpful because it visually shows how your investment will perform based on price movements up to the expiry date.

  • In the Greeks section, beyond the basic analysis tools, our Strategy Builder gets even more specific for options trading. It gives you advanced info about things like Delta, Theta, and Gamma (shown in the image below). This info helps you understand how your options will react to different market changes. Think of it as getting an inside look at how your options might behave!

  • In the Monte Carlo Analysis Section, you will learn that your PnL is heavily influenced by the course of the underlying index. Monte Carlo Analysis is a sophisticated tool for determining how your strategy will perform on average across 10000 possible price pathways that the underlying might follow till expiry. You may access this functionality by selecting "Monte Carlo Analysis" as indicated in the image below.

  • Assuming we wish to implement our Iron Fly strategy, we have two options: paper trade it ( Forward-test) or execute on a broker. To test your forward testing approach, click the forward test button in the image below.

  • You will be able to see your positions under the "Position" tab.

  • You can square off your position by clicking on squareoff button as shown in the image below.

  • You can also temporary disable/enable the positions in the strategy by clicking on toggle/untoggle button as shown in the image below.

By running multiple forward tests with different live periods and market conditions, you can gain valuable insights into the potential effectiveness and robustness of your strategy.

Modify Positions in Forward Test

You have the option to modify your strategy positions during the forward test, providing users with added flexibility to adapt their strategy to current market conditions. Follow the steps to make adjustments to your strategy.

  • Click on the View Trades button under the position tab as shown in the image below.

  • You have the option to edit the price, quantity, and position according to your preferences and save the settings, as demonstrated in the image below. This feature allows you to customize your strategy to suit your comfort level. Click the "save changes" button to apply the updated strategy

Access Past Forward Test Strategies

Traders need to analyze their past trades and identify any mistakes they made. The AlgoTest Strategy Builder allows you to access your previously saved strategies. To access past strategies in the forward test, simply follow the steps shown in the image below.

  • Go to Strategy Builder by clicking on the Strategy Builder button.

  • Click on the Strategies button on the top left corner.

  • It will show you live and forward test strategies. Click on the strategy that you want to access as shown in the image below.

  • Now you will be able to view and manage your strategy as shown in the image below.

Comparing Forward Test and Live Trade Outcomes

Remember, forward testing is a simulation, and past performance doesn't guarantee future results. Here's how forward test results should be interpreted:

  • Positive Outcomes: If your strategy performs well in forward tests across various historical periods, it indicates potential promise. However, this doesn't guarantee success in live markets.

  • Negative Outcomes: Poor forward test results suggest the strategy might be flawed or overly risky. It's crucial to refine the strategy or consider alternative approaches before risking real capital.

It's essential to understand the limitations of forward testing and use it as a stepping stone before live trading. Real-world market dynamics can be unpredictable, and factors like liquidity and execution costs can impact your actual results.

Key Differences Between Forward Testing and Live Trading

FeatureForward TestLive Trade
Order ExecutionSimulated orders assuming you got the best price available at that time.Actual orders placed in the real market
RiskNo real capital is at riskYour real capital is used for trade
PurposeEvaluate strategy performance under various scenariosExecute trades based on current market conditions, aiming to generate profits
BenefitsIdentify potential strengths and weaknesses of strategiesPotentially profit from the market if the trade is successful
DrawbacksPast performance doesn't guarantee future resultsMarkets are dynamic and can be unpredictable

With this comparison between forward test and live trade, you can gain a deeper understanding of these features.

Performance Analysis

Once you've executed your options strategies in the real market, it's crucial to analyze their past performance. This analysis will help you identify areas for improvement and potentially develop a more robust trading approach.

Here's an example to illustrate performance analysis:

Short Straddle Performance During and Post-COVID Crash

Let's consider a short straddle strategy (selling a call and a put option at the same strike price) implemented before the COVID-19 market crash. While this strategy might have profited from the initial increase in volatility during the crash, it could have suffered significant losses if the market continued to decline sharply.

This example highlights the importance of considering various market scenarios when analyzing your options strategies. Strategies that perform well in volatile markets might struggle during periods of low volatility.

By continuously analyzing the performance of your options strategies, you can learn from your successes and failures, ultimately leading to better trading decisions.