Forex for a trader
Backtesting forex meaning

Backtesting forex meaningBacktesting assesses the viability of a trading strategy by discovering how it would play out with historical data. Currency Day Trading System. Sample Selection Bias. Breaking Down 'Backtesting' Backtesting allows a trader to simulate a trading strategy using historical data to generate results and analyze risk and profitability before risking any actual capital. A well-conducted backtest that yields positive results assures traders that the strategy is fundamentally sound and is likely to yield profits when implemented in reality. A well-conducted backtest that yields suboptimal results will prompt traders to alter or reject the strategy. Particularly complicated trading strategies, such as strategies implemented by automated trading systems, rely heavily on backtesting to prove their worth, as they are too arcane to evaluate otherwise. The Ideal Backtesting Scenario. The ideal backtest chooses sample data from a relevant time period of a duration that reflects a variety of market conditions. In this way, one can better judge whether the results of the backtest represent a fluke or sound trading. The historical data set must include a truly representative sample of stocks, including those of companies which eventually went bankrupt or were sold or liquidated. The alternative, including only data from historical stocks that are still around today, will produce artificially high returns in backtesting. A backtest should consider all trading costs, however insignificant, as these can add up over the course of the backtesting period and drastically affect the appearance of a strategy’s profitability. Traders should ensure that their backtesting software accounts for these costs. The Pitfalls of Backtesting.

For backtesting to provide meaningful results, traders must develop their strategies and test them in good faith, avoiding bias as much as possible. That means the strategy should be developed without relying on the data used in backtesting. That’s harder than it seems. Traders generally build strategies based on historical data. They must be strict about testing with different data sets from those they train their models on. Otherwise, the backtest will produce glowing results that mean nothing. Similarly, traders must also avoid data dredging, in which they test a wide range of hypothetical strategies against the same set of data with will also produce successes that fail in real-time markets, because there are many invalid strategies that would beat the market over a specific time period by chance. One way to compensate for the tendency to data dredge or cherry pick is to use a strategy that succeeds in the relevant, or in-sample, time period and backtest it with data from a different, or out-of-sample, time period. If in-sample and out-of-sample backtests yield similar results, then they are likely generally valid. Forex Training Group. Have you ever been watching a currency pair and seen a familiar pattern but you were not sure how you should approach the trade? That feeling of uncertainty is one that thousands of traders feel every day. Now on the flip side, there are other traders who are more prepared and actually know what their next step should be instinctively. Many of these latter traders have spent countless hours studying and researching price patterns and movements through backtesting, and are able to execute their trade plan more effortlessly and with a higher level of confidence as a result. So, what is forex backtesting? It’s the process of using a forex strategy tester based on historical price data. You can perform a manual forex backtest by printing out graphs of exchange rates, or looking back through your charts.

In addition, you can use sophisticated complex algorithms that perform pattern recognition tasks. Whichever way you decide to backtest your forex strategies, the process itself will help you analyze situations that arise that have shown a propensity to provide a discernable edge in the market. Manual Backtesting Methods. A manual backtesting process can be timely and arduous, but it’s a true and tried method. But some of the drawbacks include, the lack of efficiency, and a greater likelihood for making an error. For example, if you are looking at a chart on a piece of paper, it might be difficult to determine if a currency pair has actually generated a lower low from the previous price point. You can mitigate this issue by working manually online, but nevertheless, the process will still be time consuming. Manual backtesting of a trading strategy will allow you to gauge whether your trade idea might be viable. You can scroll through historical data, looking to see if your ideas will work. Once you have determined the variables that you want to test extensively, an automated process might be better suited and more efficient. The first step in a manual backtesting project is to find charting software that is easy and convenient to use. It’s best if you have five or ten years of data available, especially if you are looking to back test a daily, or weekly strategy. If you are attempting to find an intra-day strategy, it might be possible to use a couple of years of data to test your ideas. Intra-day time series can encompass a lot data, and finding reliable data in this this area can sometimes be challenging. For example, if you are analyzing minute data points, you will need to evaluate 1,440 points for every day, which is more than 1-million points over a 3-year period.

Automated Backtesting Methods. There are a number of ways that you can backtest your ideas. You can use a forex simulator to test the data on your own, or you can use forex backtesting software that allows you to test basic to more sophisticated concepts. There are a plethora of free data providers including Google and Yahoo that will allow you to download historical data. Most of these data points will be daily or weekly open, high, low and close information. You can download this data into a spreadsheet such as excel, which can then be imported into your backtest platform. If you are looking to test a strategy using intra-day data such as hourly, minute or tick data, you will likely need to purchase the data from a vendor. The benefits of purchasing the data from a vendor is that typically their data has already been filtered and cleaned, removing bad ticks from the time series. Any data that you download should be tested for accuracy. You want to make sure that there are no bad data points, especially if you are relying on high and low points to enter a trade. Bad data points can generate faulty results if the data has inaccurate highs or lows which are used to generate entry or exit points. You have to really understand your strategy and determine if the data will alter the results.

For example, if you are looking at daily data, you don’t know if the high of the day occurred before or after the low of the day. This can create problem if your take profit and stop loss are near to your entry level, as your criteria could generate a signal, even if the movement of the price action did not happen in the required sequence. For example, if you enter a trade on the prior days close, and your stop loss and take profit levels are with the next day’s range, the result of the trade will depend on how your system looks at the sequence of events when evaluating stop loss and take profit levels, rather then what actually occurred. Using Back Testing Software. Another way to back test a strategy is to use computer backtesting. Many trading platforms today have trading wizards which allow the trader to create a trading model that utilizes technical indicators to establish a predefined set of rules. The criteria that is used is based on historical data points, allowing you to see if the strategy worked in the past. Mt4 strategy tester is an example of an automated backtest tool that has a built-in back testing system, in this case it is housed within the Metatrader platform. You can use their language and graphical user interface, which an efficient way to build your system on their platform. You can also use their API (application program interface), and attempt to code a system that is customized. Below is a screenshot of Mt4 strategy tester: Creating an Automated Trading System. There are several ways that you can add a systematic approach to your trading arsenal. You can program the system yourself using your own ideas and strategies, or you can have someone else program an automated system using the strategies you have created. If your trading system uses tools that are common, such as moving averages, or other technical studies, the most efficient approach to back testing will be to find use a platform like MetaTrader or Ninjatrader to back test your strategies. Learning how to use a vendor’s interface with take some time, but these systems are geared to those who have little development experience.

Standard strategies such as moving average crossovers, or overbought and oversold conditions are pre-programmed, into most back testing software packages, for your convenience. Most self-coded back testing systems are programmed in an automated trading platform that is geared toward generating a trading strategy that combines entry criteria with risk management. The criteria that is used for decision making is coded in the platform’s proprietary language. Most of these software packages have graphical user interfaces that allow you to simply click on specific variables and criteria in order to generate a strategy. If you decide that programming a system is beyond your technical capabilities or one which requires custom programming, there are freelancer programmers for hire that will help you code a system. Hiring a Freelance Programmer. There are many skilled programmers that you can hire on a freelance basis that understand the nuance of specific trading platforms. You can work with these individuals, and have them show you the results of each data series that they run with your provided strategy. But there can be some downsides to using an outside programmer. Some of the drawbacks include the additional cost you will incur from having someone else program your strategy. This includes the initial system programming, as well as the subsequent debugging process. Since you will likely need to tweak your strategy, you should try to determine how you will pay the programmer each time you ask for a change. You will have to decide whether a flat fee or hourly fee arrangement should be used. Backtesting provides you with a multitude of benefits. You will be able to determine if your strategy meets certain risk criteria and is likely to work in different market environments.

Most importantly, you have the ability to see if the methodology shows a positive historical result, prior to risking real capital. This will not guarantee profitable trading results in the future, but can help reduce the probability of potential losses. One of the benefits of programming a strategy yourself is that by doing so, you will gain intimate knowledge of how the system works and how robust your back testing results are. This will provide you more confidence when trading the system live. As we pointed out earlier, the system that you develop, is only as good as the data that you use. If the data is faulty, you will have errors in your results. Bad quotes or prints, can generate false trading signals. If you download your own data, from a free software provider, you should go through the data to see if there are any prices that look suspicious. While closing values are usually consistent, high and low values can be choppy and lead to faulty results. Purchasing a Trading System. There are dozens of commercial trading systems that are available in the market. Many have been back tested by their developers and some will advertise the spectacular returns of their system. Regarding commercially available trading systems, you should always work on the premise that if a claim is too good to be true, it’s usually too good to be true. Many times these “spectacular” systems are over optimized and curve fitted so they appear to be highly profitably based on historical data, but tend to fall apart when traded in real time. There are reviews of trading systems that you can find throughout the internet, which describe how various systems perform in real time.

One reputable resource for reviewing trading systems is Futures Truth. If you cannot find a review, make sure you test the trading system on a demo account before you employ the strategy using real capital. Issues and Pitfalls with Back Testing. As mentioned, one of the issues with back testing, and therefore purchasing a trading strategy that only shows historical results, is that there are techniques that can be used to make the strategy look good on paper but fail in real-time. By fitting the curve, or over optimizing, you can produce a system that has been back tested and looks very good over a specific historical period. A system designer can slightly alter the criteria that is used to achieve outstanding performance. For example, a designer might back test a trend following strategy optimizing a moving average crossover system for a period of 2-years. Once they find the result that looks good, they test to see if the strategy works over a longer period. Most of the time, the results will be fair at best, over the long term, but they will not tell you this when you purchase your system. You could find out only later than the moving average crossover strategy that returned 100 % over the past 2-years, loses 20 % when you test it over the past 10-years. What you want to be able to do is see how that system performs in a forward test or better yet in a real-time trading environment.

In addition, many novice traders sometimes assume that a trading system should have a very high percentage of winning trades. With this in mind, an unscrupulous designer can create parameters that can be adjusted to create an amazing win rate of over 90% for example. This may seem attractive to the untrained eye, but in the vast majority of cases, this type of system will eventually blow up, because the losses will be many multiples of any winning trade the system generates. Removing Negative Emotions from Your Trading. A system that is backtested helps remove some of the human emotion from a trade. Many investors are calmed by the notion that a trade has worked well in the past. This is especially helpful when a trade is moving against you and you are losing money. You are more likely to hold on and let the trade play out, as opposed to cutting bait, assuming that is what your system calls for doing. An important metric that a backtested trading strategy or system will provide you with is the maximum drawdown.

This calculation tells you the largest peak to trough decline in a portfolio. When you back test your strategy you should calculate the maximum drawdown to see the largest drop that the strategy has experienced. Past calculations of maximum drawdown will give you an idea of what you can expect if you experience an adverse market condition, and will allow you to better plan on this experience as the potential worst case scenario. But in most cases, keep in mind, that your worst drawdown is ahead of you not behind you. If you backtested a system for 10 years where you are investing 10K and your maximum drawdown was $1,500 which is 15%, then you would typically not expect to lose more than 15-20% on your system during the years to follow. If you back tested your system in multiple market environments, this type of analysis will help you determine how carefully you need to monitor your system, when a position starts moving against you in a way that was unexpected. If your system has a new maximum drawdown that is 2-times the prior maximum drawdown, you may need to re-evaluate the backtest history or adjust your risk parameters. While negatively charged emotions can be somewhat minimized when you begin to trade a system that has been back tested, it can still play a role in your decision processes. You need to give a new system the appropriate amount of time to determine if it works. Given the results of your system, you should plan in advance what you are expecting, and what you think you should do if the results in real-time are not as you planned. You should also spend time forward testing your strategy using a practice account as opposed to real capital. Do this for a few weeks or months and make sure that the backtested system is generating the returns you expected before attempting to use real capital with your strategy. If you developed the system yourself, and backtested it, you might become attached to your strategy and fail to pull the plug on it even if it does not perform as planned.

Make sure you stick to a game plan and have benchmarks that describe your goals. Backtesting is an excellent was to determine if a trading strategy has the potential to work in the future. Keep in mind, that just because a system’s past results are positive, does not necessarily mean your strategy will work in the future. But it should provide you more confidence in your execution. And that is the best that we as traders can hope for. We are not executing on certainty, we are executing on probabilities. Make sure the data you use for the backtest is clean, and does not have false highs and lows. Be particularly careful if you are trading a system that relies on intra-day data. Calculate the maximum drawdown so you understand the most you could expect lose from peak to trough, and be sure to test your strategy with demo money before you decide to risk real capital. Backtest method and results (2001 - 2013) Last updated on 22122012. The forex beginner strategy is an easy learning tool that allows you to practice trading in a simple and beginner-friendly way. We recommend that you trade on a demo account with play money, until you are experienced enough to make a conscious and risk-aware decision whether to trade for real money. At the same time you can explore different trading concepts, other ways of analysing charts and start developing your own strategies and ways of trading. In this lesson, we will show you the backtesting results of the forex beginner strategy for the EURUSD currency pair since January 2001. A backtest simulates the performance of a strategy based on historical data, to estimate how a strategy would have performed if it had been used. Things to bear in mind when looking at backtesting results. There are key points that you must be aware of before looking into backtest results.

Past performance is not indicative of future results. The forex market environment can change, and this can significantly impact the performance of a strategy. Thus, a trading strategy that would have been very successful in the past years might not be successful going forward. Experienced forex traders are often able to judge under which overall marketing conditions a strategy can be expected to do well. Until you have gained such knowledge, be careful before relying on any one strategy. Backtesting is not an exact science. There are different factors that influence the outcome of a backtest. For example, different forex brokers will have different spreads, and so using a variety of brokers will produce variations in the results. Another thing to bear in mind is that price feeds also vary between brokers, which means that indicators such as fractals could appear at different spots depending on the data used.

Then, there will also be difference based on whether a backtest is done algorithmically or whether it is done by a real person going over historical price data. In our case, we used an algorithmic approach to reduce the impact of human error. Finally, there is a difference between backtesting a trading strategy and applying a strategy in a real environment. In a real environment you are more likely to make mistakes or react a bit too slowly to changes in price. Also, depending on your broker, factors such as execution speed and slippage might impact the results. Trading large positions can yield different results. The larger an account gets, the more you can risk and hence more volume you can trade. However, trading very large amounts can actually produce a unique problems, because you can actually move the price of the asset you are trading, simply by putting on a trade. This tends not to be an issue when trading very small sizes, however you should note that when you start to approach a large enough volume, you may actually move the price. This could potentially give you slower execution as well as less desirable prices in order for your entire order to be filled. The backtesting method used. As the rules of the basic beginner strategy are purely mechanical, we created an algorithm that applies the strategy to real historical EURUSD data ranging from 1st January 2001 until 30th November 2012. The algorithm was instructed to only consider trades that happen in the EURUSD prime time, which is from 8:00 GMT until 17:30 GMT. After 17:30 GMT, no new trades were opened. All remaining open trades were closed at 18:00 GMT. For the test, we assumed an average spread of 1.5 pips.

The algorithm worked on the bid prices, with the spread being substracted from the end result of the trade. Note that when trading for real, one needs to take into account the spread when setting up the trades. We also assumed a 0.4 pip distance between any candle highlow and the fractal tip. The money management method used was not the general method given in the beginner strategy. Instead we used the advance method of determining the pip size, called the optimal position size. We used our best efforts to make the backtesting as accurate as possible using the above method, but can give no guarantee that our backtest has been error free. The above method generated 7000 trades in the time period. You can download an excel file giving the details of each trade here: The 7000 trades in this period of time were then analysed: How does the profitability in pips translate to returns? In order to determine how a profit in pips translates into an actual profit, the position sizes used are key. Larger position sizes mean higher risk, but also higher returns. We have simulated the fictional returns of the beginner strategy backtest using the following simulation: We took a fictional starting capital of 100,000 USD. For each trade, we determined the position size based on risking 2% of the total equity on any single trade.

This means that if the stop loss was hit in any trade, exactly 2% of the capital would be lost. To determine the amount of capital gained or lost per pip in a given trade we used the following formula: Capital gained or lost per pip = (Max risk per trade)(Distance entry price to initial stop loss in pip) Where Risk per trade = Trading capital * 0.02. As each trade affects our trading capital – it will increase, decrease or stay the same depending on the result of the trade – it is recalculated after each trade by adding the respective profit or loss. Using this approach, and again assuming a spread of 1.5 pip, we get the following results: If you would like to look at the charts for each year, then you can check the following lesson. Again, we would like to remind you that past performance of a backtest is not indicative of future results. The forex beginner strategy is a learning tool that allows you to practice trading in a simple and beginner-friendly way. We recommend you to trade on a demo account with play money until you are experienced enough to make a conscious and risk-aware decision about whether to trade for real money. If you decide to use the beginner strategy for real money trading, you do so at your own risk. How to Backtest a Trading Strategy. How to backtest a trading strategy is probably one of those boring but necessary things that you need to learn if you ever want to have confidence in your trading strategy. Whether you have a mechanical trading system or if you simply have some sort of discretion and a human input into your trading approach, backtesting remain mandatory. Our team at TSG has a pragmatic take on strategy backtesting. All of our trading strategies have been thoughtful backtested so it can prove to ourselves that we have an edge in the market. Many traders have asked whether or not backtesting is useful? Yes, it can be useful especially if you use dedicated backtesting software .

However, you have to keep in mind that there are also many limitations when you look at your trading strategy in hindsight. There are all sorts of different things that you can’t incorporate when backtesting so it can feel like real trading. Obviously, backtesting is not live trading so you don’t have the emotions within your trading to properly show realistic backtesting results. Nevertheless, trading strategy backtesting remains an important part of achieving trading success. Moving forward we’re going to discuss the importance of backtesting and more importantly, you’ll learn how to backtest a trading strategy. We also have training for the best Gann Fan trading strategy. The Importance of Trading Strategy Backtesting. Trading strategy backtesting plays an important part in developing your trading strategy. However, backtesting is just the start because the immediate step is to forward test your strategy. The primary purpose of backtesting is to prove that you have valid trade ideas. If your Forex strategy has a proven edge then you’ll be more confident to pull the trigger when the next trade signal shows up. In other words, you’ll be able to better deal with the emotional side of trading which is one of the biggest hurdles to conquer.

The other benefit of using backtesting software is that it will help you skip weeks and months of trading failure depending on your time frame. You can actually go through year’s worth of Forex price data in a matter of few minutes. So, no matter what your trading rules are, you can use any backtesting software to test the reliability of your trading strategy. The bottom line is that learning how to backtest a trading strategy can help your Forex results. How to Backtest a Trading Strategy. You want to make sure that you have very specific rules for your Forex strategy. So you know exactly when to take the trade every single time you see it on the chart. That is the only way you’re going to be consistent in what you trade. If you don’t have specific trading rules for your setups that you can follow every single time you take a trade then it will be impossible for you to even backtest your trading strategy. There are two basic ways to backtest a trading strategy: Automated backtesting that’s dedicated to people who are good at coding. This is also the most efficient way to backtest a trading strategy because the backtest results are unaltered. Manual backtesting by which you go manually through the charts and find the trades that fits into your trading rules. You need three things to analyze your trading strategy and hopefully create a million-dollar strategy: The first thing you’ll need is the price data itself or a charting package. Secondly you need backtesting software or a program that can accurately manipulate the price data and apply your trading ideas to it. Most importantly you need an open mind or imagination to think of creative trading ideas to backtest.

For the purpose of this article we’re going to use a double top and double bottom trading strategy. So, now that we know what kind of strategy we’re going to be backtesting we’re going to highlight the key components needed not just to backtest this kind of strategy but they are universal components that can be used as a template for backtesting any type of strategy. Also, read bankers way of trading in forex market. Without further ado, this is how to manually backtest a trading strategy the right way and these are a few of the variables you want to keep track of: What currency pair we backtest our strategy? The first bit of information that we need to know is what currency pair or what financial instrument we spotted the double topdouble bottom pattern. Each financial instrument or currency pair has its own personality and the backtesting process can reveal what currency pair offers the most accurate and profitable double topdouble bottom patterns. Here is another strategy called Time-Based Trading Strategy. The date you spotted the chart pattern. We definitely want to know the date of the trade that we’ve spotted. Some days tend to be more volatile and the through trading strategy backtesting you might find what are the best days for these patterns.

If you find enough and strong evidence that some days tend to produce better results for the double topdouble bottom pattern then you should focus more to take the trades during those days with the best potential. We need to know the time of the day we took the trade as well. The same as not every trading day is created equal the same holds true for the time of the day. For example, the Forex market can be divided into four major trading sessions. Your backtesting results should show you what the best Forex trading session is. Is it the London session? Or, maybe it’s the New York session? These are all important backtesting parameters that need to be tested. Stop Loss and Profit Targets. We probably want to know the stop loss, the profit target and the number of pips that we’ve made or lost on the trade. While the stop loss is pretty much rigid we can backtest different take profit strategies.

You can be creative and use your trading experience to find the best trading strategy. Rules for the entry strategy. You want to make sure that you have very strict trading rules for your trade setup. For the propose of this article, as we already mentioned, we’re going to backtest the double top double bottom chart patterns as our main trading strategy. The rule number one for our double top pattern is that on the retest of the first high the wick must at least touch the top of the body of the previous swing high. Allow us to zoom on a price chart and show you what we mean by that: Our second rule for the double top is that the body of the retest can’t close above the wick of the previous swing high. We hope the rules make sense. They are the same for the double bottom chart pattern. Now we have a specific set of rules that we can follow and which will tell me when a double topdouble bottom pattern was created. This gives us something that we can test. The next step is to figure out how we’re going to enter the market if these specific trading rules are met. Are we going to enter on the close of the second candle top? Are we going to wait for a small retracement? Or, are we going to do the most common thing and wait for the break of the neckline? These are all valid entry criteria that can be backtested and see which one yields a better profit outcome. Now, that we have created our entry techniques we need a stop and take profit strategy.

We can place our protective stop loss above the double top because a break above will ultimately invalidate the level. When it comes to our take profit strategy we can be more flexible and backtest all kind of take profit variations. Now we have a framework and we know exactly how we’re going to trade this every single time it happens in the market. For this specific strategy, this is pretty much everything we need to backtest this Forex strategy. At the end you should have a backtesting spreadsheet where you should manually record all the inputs, the same as in the figure below: Now, back to the charts try to find some of this trading example and record them in the backtesting spreadsheet and see if you can find an edge. Trading strategy backtesting requires manipulating the backtesting parameters in order to find the most promising trading strategy. This way you’ll ensure that you maximize your profits on your trading ideas. No matter how you put it backtesting is vital for determining the viability of a trading strategy. You can also read our winning news trading strategy. If you want to be able to execute your trades with confidence you need to learn how to backtest a trading strategy. Thank you for reading! Please leave a comment below if you have any questions about trading strategy backtesting! Also, please give this strategy a 5 star if you enjoyed it! Please Share this Strategy Below and keep it for your own personal use! Thanks Traders! Backtesting in MetaTrader 4 – Testing & Optimization in MetaTrader 4 for Beginners Tutorial Part 3. Investopedia defines backtesting as “ The process of testing a trading strategy on prior time periods.

Instead of applying a strategy for the time period forward, which could take years, a trader can do a simulation of his or her trading strategy on relevant past data in order to gauge the its effectiveness” In today’s tutorial we will expand on this definition. We will explore the different types of backtesting and I will show you why backtests are so valuable, how they can save you time and make your add certainty to your Forex algo-trading. Let me know if you have any questions using the comments section below. I am always happy to assist you with questions. GET STARTED WITH THE FOREX TRADING ACADEMY. I'm a Forex Trader, a Data Scientist, an Entrepreneur, an Online Coach. Those are my main occupations. I've been into Forex Trading since 2007 and, as they say, I've seen the good, the bad, and the ugly. I've survived the GFC and learned a lot along the way. Today I want to share all my knowledge and insights with you. Algorithmic Trading (1) Course: Forex Trading for Beginners (6) Course: MQL4 for Complete Beginners (48) Course: Strategy Tester for Beginners (11) FOREX (89) Forex Strategy (89) Forex Trading for Beginners (74) Forex VPS (1) Fundamental Analysis (3) Interviews (1) Miscellaneous (4) MQL4 (2) Technical Analysis (12) GET STARTED WITH THE FOREX TRADING ACADEMY. Forexboat Pty Ltd (ABN: 29 609 855 414) a Corporate Authorised Representative (AR No. 001238951) of HLK Group Pty Ltd (ACN: 161 284 500) which holds an Australian Financial Services Licence (AFSL no. 435746). Any information or advice contained on this website is general in nature only and does not constitute personal or investment advice. We will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from the use of or reliance on such information.

You should seek independent financial advice prior to acquiring a financial product. All securities and financial products or instruments transactions involve risks. Please remember that past performance results are not necessarily indicative of future results. The information on this site may be accessed worldwide however it is not directed at residents in any country or jurisdiction where such distribution or use would be contrary to local law or regulation. Forexboat Pty Ltd is not registered with any US regulator including the National Futures Association (“NFA”) and Commodity Futures Trading Commission (“CFTC”) therefore products and services offered on this website is not intended for residents of the United States. Forex Training Group. Have you ever been watching a currency pair and seen a familiar pattern but you were not sure how you should approach the trade? That feeling of uncertainty is one that thousands of traders feel every day. Now on the flip side, there are other traders who are more prepared and actually know what their next step should be instinctively. Many of these latter traders have spent countless hours studying and researching price patterns and movements through backtesting, and are able to execute their trade plan more effortlessly and with a higher level of confidence as a result. So, what is forex backtesting? It’s the process of using a forex strategy tester based on historical price data. You can perform a manual forex backtest by printing out graphs of exchange rates, or looking back through your charts.

In addition, you can use sophisticated complex algorithms that perform pattern recognition tasks. Whichever way you decide to backtest your forex strategies, the process itself will help you analyze situations that arise that have shown a propensity to provide a discernable edge in the market. Manual Backtesting Methods. A manual backtesting process can be timely and arduous, but it’s a true and tried method. But some of the drawbacks include, the lack of efficiency, and a greater likelihood for making an error. For example, if you are looking at a chart on a piece of paper, it might be difficult to determine if a currency pair has actually generated a lower low from the previous price point. You can mitigate this issue by working manually online, but nevertheless, the process will still be time consuming. Manual backtesting of a trading strategy will allow you to gauge whether your trade idea might be viable. You can scroll through historical data, looking to see if your ideas will work. Once you have determined the variables that you want to test extensively, an automated process might be better suited and more efficient. The first step in a manual backtesting project is to find charting software that is easy and convenient to use. It’s best if you have five or ten years of data available, especially if you are looking to back test a daily, or weekly strategy. If you are attempting to find an intra-day strategy, it might be possible to use a couple of years of data to test your ideas. Intra-day time series can encompass a lot data, and finding reliable data in this this area can sometimes be challenging.

For example, if you are analyzing minute data points, you will need to evaluate 1,440 points for every day, which is more than 1-million points over a 3-year period. Automated Backtesting Methods. There are a number of ways that you can backtest your ideas. You can use a forex simulator to test the data on your own, or you can use forex backtesting software that allows you to test basic to more sophisticated concepts. There are a plethora of free data providers including Google and Yahoo that will allow you to download historical data. Most of these data points will be daily or weekly open, high, low and close information. You can download this data into a spreadsheet such as excel, which can then be imported into your backtest platform. If you are looking to test a strategy using intra-day data such as hourly, minute or tick data, you will likely need to purchase the data from a vendor. The benefits of purchasing the data from a vendor is that typically their data has already been filtered and cleaned, removing bad ticks from the time series. Any data that you download should be tested for accuracy. You want to make sure that there are no bad data points, especially if you are relying on high and low points to enter a trade. Bad data points can generate faulty results if the data has inaccurate highs or lows which are used to generate entry or exit points. You have to really understand your strategy and determine if the data will alter the results. For example, if you are looking at daily data, you don’t know if the high of the day occurred before or after the low of the day. This can create problem if your take profit and stop loss are near to your entry level, as your criteria could generate a signal, even if the movement of the price action did not happen in the required sequence. For example, if you enter a trade on the prior days close, and your stop loss and take profit levels are with the next day’s range, the result of the trade will depend on how your system looks at the sequence of events when evaluating stop loss and take profit levels, rather then what actually occurred.

Using Back Testing Software. Another way to back test a strategy is to use computer backtesting. Many trading platforms today have trading wizards which allow the trader to create a trading model that utilizes technical indicators to establish a predefined set of rules. The criteria that is used is based on historical data points, allowing you to see if the strategy worked in the past. Mt4 strategy tester is an example of an automated backtest tool that has a built-in back testing system, in this case it is housed within the Metatrader platform. You can use their language and graphical user interface, which an efficient way to build your system on their platform. You can also use their API (application program interface), and attempt to code a system that is customized. Below is a screenshot of Mt4 strategy tester: Creating an Automated Trading System. There are several ways that you can add a systematic approach to your trading arsenal.

You can program the system yourself using your own ideas and strategies, or you can have someone else program an automated system using the strategies you have created. If your trading system uses tools that are common, such as moving averages, or other technical studies, the most efficient approach to back testing will be to find use a platform like MetaTrader or Ninjatrader to back test your strategies. Learning how to use a vendor’s interface with take some time, but these systems are geared to those who have little development experience. Standard strategies such as moving average crossovers, or overbought and oversold conditions are pre-programmed, into most back testing software packages, for your convenience. Most self-coded back testing systems are programmed in an automated trading platform that is geared toward generating a trading strategy that combines entry criteria with risk management. The criteria that is used for decision making is coded in the platform’s proprietary language. Most of these software packages have graphical user interfaces that allow you to simply click on specific variables and criteria in order to generate a strategy. If you decide that programming a system is beyond your technical capabilities or one which requires custom programming, there are freelancer programmers for hire that will help you code a system. Hiring a Freelance Programmer. There are many skilled programmers that you can hire on a freelance basis that understand the nuance of specific trading platforms. You can work with these individuals, and have them show you the results of each data series that they run with your provided strategy. But there can be some downsides to using an outside programmer. Some of the drawbacks include the additional cost you will incur from having someone else program your strategy.

This includes the initial system programming, as well as the subsequent debugging process. Since you will likely need to tweak your strategy, you should try to determine how you will pay the programmer each time you ask for a change. You will have to decide whether a flat fee or hourly fee arrangement should be used. Backtesting provides you with a multitude of benefits. You will be able to determine if your strategy meets certain risk criteria and is likely to work in different market environments. Most importantly, you have the ability to see if the methodology shows a positive historical result, prior to risking real capital. This will not guarantee profitable trading results in the future, but can help reduce the probability of potential losses. One of the benefits of programming a strategy yourself is that by doing so, you will gain intimate knowledge of how the system works and how robust your back testing results are. This will provide you more confidence when trading the system live. As we pointed out earlier, the system that you develop, is only as good as the data that you use. If the data is faulty, you will have errors in your results.

Bad quotes or prints, can generate false trading signals. If you download your own data, from a free software provider, you should go through the data to see if there are any prices that look suspicious. While closing values are usually consistent, high and low values can be choppy and lead to faulty results. Purchasing a Trading System. There are dozens of commercial trading systems that are available in the market. Many have been back tested by their developers and some will advertise the spectacular returns of their system. Regarding commercially available trading systems, you should always work on the premise that if a claim is too good to be true, it’s usually too good to be true. Many times these “spectacular” systems are over optimized and curve fitted so they appear to be highly profitably based on historical data, but tend to fall apart when traded in real time. There are reviews of trading systems that you can find throughout the internet, which describe how various systems perform in real time.

One reputable resource for reviewing trading systems is Futures Truth. If you cannot find a review, make sure you test the trading system on a demo account before you employ the strategy using real capital. Issues and Pitfalls with Back Testing. As mentioned, one of the issues with back testing, and therefore purchasing a trading strategy that only shows historical results, is that there are techniques that can be used to make the strategy look good on paper but fail in real-time. By fitting the curve, or over optimizing, you can produce a system that has been back tested and looks very good over a specific historical period. A system designer can slightly alter the criteria that is used to achieve outstanding performance. For example, a designer might back test a trend following strategy optimizing a moving average crossover system for a period of 2-years. Once they find the result that looks good, they test to see if the strategy works over a longer period. Most of the time, the results will be fair at best, over the long term, but they will not tell you this when you purchase your system.

You could find out only later than the moving average crossover strategy that returned 100 % over the past 2-years, loses 20 % when you test it over the past 10-years. What you want to be able to do is see how that system performs in a forward test or better yet in a real-time trading environment. In addition, many novice traders sometimes assume that a trading system should have a very high percentage of winning trades. With this in mind, an unscrupulous designer can create parameters that can be adjusted to create an amazing win rate of over 90% for example. This may seem attractive to the untrained eye, but in the vast majority of cases, this type of system will eventually blow up, because the losses will be many multiples of any winning trade the system generates. Removing Negative Emotions from Your Trading. A system that is backtested helps remove some of the human emotion from a trade. Many investors are calmed by the notion that a trade has worked well in the past. This is especially helpful when a trade is moving against you and you are losing money.

You are more likely to hold on and let the trade play out, as opposed to cutting bait, assuming that is what your system calls for doing. An important metric that a backtested trading strategy or system will provide you with is the maximum drawdown. This calculation tells you the largest peak to trough decline in a portfolio. When you back test your strategy you should calculate the maximum drawdown to see the largest drop that the strategy has experienced. Past calculations of maximum drawdown will give you an idea of what you can expect if you experience an adverse market condition, and will allow you to better plan on this experience as the potential worst case scenario. But in most cases, keep in mind, that your worst drawdown is ahead of you not behind you. If you backtested a system for 10 years where you are investing 10K and your maximum drawdown was $1,500 which is 15%, then you would typically not expect to lose more than 15-20% on your system during the years to follow. If you back tested your system in multiple market environments, this type of analysis will help you determine how carefully you need to monitor your system, when a position starts moving against you in a way that was unexpected. If your system has a new maximum drawdown that is 2-times the prior maximum drawdown, you may need to re-evaluate the backtest history or adjust your risk parameters. While negatively charged emotions can be somewhat minimized when you begin to trade a system that has been back tested, it can still play a role in your decision processes. You need to give a new system the appropriate amount of time to determine if it works. Given the results of your system, you should plan in advance what you are expecting, and what you think you should do if the results in real-time are not as you planned. You should also spend time forward testing your strategy using a practice account as opposed to real capital. Do this for a few weeks or months and make sure that the backtested system is generating the returns you expected before attempting to use real capital with your strategy. If you developed the system yourself, and backtested it, you might become attached to your strategy and fail to pull the plug on it even if it does not perform as planned. Make sure you stick to a game plan and have benchmarks that describe your goals.

Backtesting is an excellent was to determine if a trading strategy has the potential to work in the future. Keep in mind, that just because a system’s past results are positive, does not necessarily mean your strategy will work in the future. But it should provide you more confidence in your execution. And that is the best that we as traders can hope for. We are not executing on certainty, we are executing on probabilities. Make sure the data you use for the backtest is clean, and does not have false highs and lows. Be particularly careful if you are trading a system that relies on intra-day data. Calculate the maximum drawdown so you understand the most you could expect lose from peak to trough, and be sure to test your strategy with demo money before you decide to risk real capital. How to Backtest a Trading Strategy. How to backtest a trading strategy is probably one of those boring but necessary things that you need to learn if you ever want to have confidence in your trading strategy. Whether you have a mechanical trading system or if you simply have some sort of discretion and a human input into your trading approach, backtesting remain mandatory. Our team at TSG has a pragmatic take on strategy backtesting. All of our trading strategies have been thoughtful backtested so it can prove to ourselves that we have an edge in the market. Many traders have asked whether or not backtesting is useful?

Yes, it can be useful especially if you use dedicated backtesting software . However, you have to keep in mind that there are also many limitations when you look at your trading strategy in hindsight. There are all sorts of different things that you can’t incorporate when backtesting so it can feel like real trading. Obviously, backtesting is not live trading so you don’t have the emotions within your trading to properly show realistic backtesting results. Nevertheless, trading strategy backtesting remains an important part of achieving trading success. Moving forward we’re going to discuss the importance of backtesting and more importantly, you’ll learn how to backtest a trading strategy. We also have training for the best Gann Fan trading strategy. The Importance of Trading Strategy Backtesting. Trading strategy backtesting plays an important part in developing your trading strategy. However, backtesting is just the start because the immediate step is to forward test your strategy. The primary purpose of backtesting is to prove that you have valid trade ideas.

If your Forex strategy has a proven edge then you’ll be more confident to pull the trigger when the next trade signal shows up. In other words, you’ll be able to better deal with the emotional side of trading which is one of the biggest hurdles to conquer. The other benefit of using backtesting software is that it will help you skip weeks and months of trading failure depending on your time frame. You can actually go through year’s worth of Forex price data in a matter of few minutes. So, no matter what your trading rules are, you can use any backtesting software to test the reliability of your trading strategy. The bottom line is that learning how to backtest a trading strategy can help your Forex results. How to Backtest a Trading Strategy. You want to make sure that you have very specific rules for your Forex strategy. So you know exactly when to take the trade every single time you see it on the chart. That is the only way you’re going to be consistent in what you trade. If you don’t have specific trading rules for your setups that you can follow every single time you take a trade then it will be impossible for you to even backtest your trading strategy. There are two basic ways to backtest a trading strategy: Automated backtesting that’s dedicated to people who are good at coding. This is also the most efficient way to backtest a trading strategy because the backtest results are unaltered. Manual backtesting by which you go manually through the charts and find the trades that fits into your trading rules.

You need three things to analyze your trading strategy and hopefully create a million-dollar strategy: The first thing you’ll need is the price data itself or a charting package. Secondly you need backtesting software or a program that can accurately manipulate the price data and apply your trading ideas to it. Most importantly you need an open mind or imagination to think of creative trading ideas to backtest. For the purpose of this article we’re going to use a double top and double bottom trading strategy. So, now that we know what kind of strategy we’re going to be backtesting we’re going to highlight the key components needed not just to backtest this kind of strategy but they are universal components that can be used as a template for backtesting any type of strategy. Also, read bankers way of trading in forex market. Without further ado, this is how to manually backtest a trading strategy the right way and these are a few of the variables you want to keep track of: What currency pair we backtest our strategy? The first bit of information that we need to know is what currency pair or what financial instrument we spotted the double topdouble bottom pattern. Each financial instrument or currency pair has its own personality and the backtesting process can reveal what currency pair offers the most accurate and profitable double topdouble bottom patterns. Here is another strategy called Time-Based Trading Strategy. The date you spotted the chart pattern. We definitely want to know the date of the trade that we’ve spotted. Some days tend to be more volatile and the through trading strategy backtesting you might find what are the best days for these patterns. If you find enough and strong evidence that some days tend to produce better results for the double topdouble bottom pattern then you should focus more to take the trades during those days with the best potential. We need to know the time of the day we took the trade as well. The same as not every trading day is created equal the same holds true for the time of the day. For example, the Forex market can be divided into four major trading sessions.

Your backtesting results should show you what the best Forex trading session is. Is it the London session? Or, maybe it’s the New York session? These are all important backtesting parameters that need to be tested. Stop Loss and Profit Targets. We probably want to know the stop loss, the profit target and the number of pips that we’ve made or lost on the trade. While the stop loss is pretty much rigid we can backtest different take profit strategies. You can be creative and use your trading experience to find the best trading strategy. Rules for the entry strategy. You want to make sure that you have very strict trading rules for your trade setup. For the propose of this article, as we already mentioned, we’re going to backtest the double top double bottom chart patterns as our main trading strategy.

The rule number one for our double top pattern is that on the retest of the first high the wick must at least touch the top of the body of the previous swing high. Allow us to zoom on a price chart and show you what we mean by that: Our second rule for the double top is that the body of the retest can’t close above the wick of the previous swing high. We hope the rules make sense. They are the same for the double bottom chart pattern. Now we have a specific set of rules that we can follow and which will tell me when a double topdouble bottom pattern was created. This gives us something that we can test. The next step is to figure out how we’re going to enter the market if these specific trading rules are met. Are we going to enter on the close of the second candle top? Are we going to wait for a small retracement? Or, are we going to do the most common thing and wait for the break of the neckline? These are all valid entry criteria that can be backtested and see which one yields a better profit outcome. Now, that we have created our entry techniques we need a stop and take profit strategy. We can place our protective stop loss above the double top because a break above will ultimately invalidate the level.

When it comes to our take profit strategy we can be more flexible and backtest all kind of take profit variations. Now we have a framework and we know exactly how we’re going to trade this every single time it happens in the market. For this specific strategy, this is pretty much everything we need to backtest this Forex strategy. At the end you should have a backtesting spreadsheet where you should manually record all the inputs, the same as in the figure below: Now, back to the charts try to find some of this trading example and record them in the backtesting spreadsheet and see if you can find an edge. Trading strategy backtesting requires manipulating the backtesting parameters in order to find the most promising trading strategy. This way you’ll ensure that you maximize your profits on your trading ideas. No matter how you put it backtesting is vital for determining the viability of a trading strategy. You can also read our winning news trading strategy. If you want to be able to execute your trades with confidence you need to learn how to backtest a trading strategy. Thank you for reading!

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