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How to backtest your forex trading strategies

Backtesting is one of the important things a trader needs to do before using a trading strategy, especially if one wants to use an automated trading system. As the name implies, backtesting is where a trader would test their strategy on historical data. This is useful as the backtesting exercise allows traders to understand how their trading strategy would have fared on historical data.

It also allows traders to understand if there are any cracks. It is important to note that past performance does not guarantee future results. But having said that, back testing allows you to get an idea about your trading strategy and also understand what market conditions your trading strategy would work best on.

You can back test your trading strategy either by automating it and then creating an expert advisor, or alternately, you could make use of a semi-automated indicator and use this indicator to see how your trading system would have fared. Back testing simply helps you to build more confidence in your trading system.

Before you start back testing you should of course have a forex trading strategy in place.

How to back test your trading strategy?

First and foremost, you need to have a trading strategy. This means that you should know what indicators you are using in your trading system as well as the rules that determine the buy and sell signals that you would take.

You should also look at the currency pairs or instruments that you think your trading system is best suited for. Many traders make the mistake of using a forex trading strategy on index CFD's or vice versa. But each market has its own characteristics, and this can change the performance of the trading results.

After this, you could either automate the strategy into an expert advisor that will trade on your behalf, or you could build a custom indicator that can either plot up and down arrows or alert you via a pop up or a push notification.

Once you have the required indicator or expert advisor, you can then use the MT4 back testing module to get started. The first thing you need here is good data. This means that you should download all the historical data for the currency pair that your trading system is intended to be used on.

Understanding the results from back testing

If you are using an expert advisor, then you should select the time frame of the instrument that you want to trade on, the account balance, spread of the instrument and so on. Following this, you should also set the parameters of your EA. These includes the lot size, and any other settings that your expert advisor allows you to configure.

Once you have configured the expert advisor, you should then start running the expert advisor. There are two ways to back test your EA. The first is to use the visual mode. The visual mode allows you to see the price action and the trading signals that come with it.

This is useful if you are back testing an indicator for example. On the other hand, if you are using just an expert advisor, you could use the automatic mode. In this mode, there won’t be any visual buy or sell signals. The back test is also faster in this second mode.

We recommend that traders should test their EA both in visual and automatic mode, to get an idea if the trading strategy does indeed work or not.

Once your back testing is done, you would get a list of statistics. You can export this into an HTML file and then analyze it in detail. As we outlined in the earlier articles, you should be able to read the statistics of your trading results.

Pitfalls to avoid when back testing

Many traders tend to often fine tune their EA settings so that it looks good on the backtesting history. However, this can be dangerous. On one hand, you are configuring your EA so that the results look good on a backtest data.

This does not guarantee that you will see the same results when you are forward testing. As a result, traders need to find a balance between backtesting results so that they don’t end up curve fitting their EA only so that it looks good on historical data.

Following the back testing, traders should switch to forward testing. This means that you use your EA on a demo account or a cent account so that it trades in the real or in a demo environment, but in forward looking markets.

Many traders tend to rush up with their EA and often cut corners. But if you are serious about truly building a profitable forex trading strategy, then patience is highly rewarded.

Read 106 times Last modified on Friday, 04 December 2020 11:53