As we all know to make profit in forex trading
you ought to treat it as a business and to do that takes a lot of experience
which will take several years but if I told you that it can be accomplished
within few month would you believe me?
Developing a trading strategy takes time and a
most need for a trader because it acts like a nest when fishing in this great ocean
called FOREX. To develop this strategy you definitely need this approach we are
about to show you.
Most strategy are copied as they say ‘‘nothing
new is under the sun’’ but the question, is the strategy worth your time? Can
it be able to achieve you aim via this strategy? Do you have confidence in you
strategy? All this will be answered via this approach.
To avoid wasting money and also to check what
condition suit your strategy we apply the approach called back testing.
WHAT
IS BACKTESTING?
Back testing is the process of testing a trading strategy via historical
data, to see how it would have performed in the past. In theory, if a system
worked well in the past, it will continue to do so in the future due to history
always repeats itself.
For example, let's say that you wanted to test a simple Relative
Strength Index (RSI) trading strategy. Your trading strategy entry may look
something like this:
Enter a trade when the indicator crosses back from 70 (overbought) / 30(oversold)
But the stop above/below the most recent high/low
Set a 3X risk profit target
Risk 1% per trade
Here are a couple of examples of sell signals.
Here are a couple of examples on buy signal also
In order to find out if this is strategy might be profitable, you would
test it on as much historical data as possible. A common back testing period
would be 10years and above
Testing over a longer period of time like this allows you to see how the
strategy performs during different market conditions. If you only test in one
type of market, you will get a much skewed look at the performance of the
system.
Testing it in a trending market, then of course it will do well! But what
about testing it in a choppy market, what will be the outcome? You find out.
After checking you might discover that your strategy may work well on a
trendy market than on a choppy market so you will begin to build your strategy
around a trending market but the truth remain we don’t know what will happen
next so you have to apply the profit loss ratio so each time you win you get
times 2 and above of your loss in that way if you take 10 trades you just need
3 win to hit above losing via that strategy.
TYPES OF BACKTESTING
Some traders believe you must be a programmer to get into this area, now
that’s not true because anyone can back test. It base on choice and we have two
option:
1. AUTOMATED BACKTESTING:
This is for the programmers, you write a program that open and close a
trade alongside your signals. It can either be bought or created by you like I
said it’s for programmers.
CONS
v Trade freely no emotion attached to a trade
v Can be leverage on a copy trade service
v Make money while sleeping
DOWNSIDES
v
One misplaced comma in the code and
you could lose your entire account. It has to be tested
extensively.
v
You need to know the exact parameters
of the trading system, so you know when it stops working.
v
Even though the system is automated,
you still need to check it on a regular basis. Is the technology working? Has
the market changed?
v
No guarantee that it will work in
live trading, has to be forward tested first.
v
The system needs to fit your
personality and risk tolerance
v
You have to understand coding (can be
time consuming to learn) or you have to hire a programmer (which can get
expensive).
v
Not all trading methods can be
properly translated into an automated system.
I still don’t use automated just don’t like it but that’s my opinion,
what’s yours?
2. MANUAL BACK TESTING
Now let's take a look at manual back testing.
CONS
·
You get to feel the pressure of a
live trading even though you are trading demo due to make all the trade execution
which can help you improve tremendously.
·
Anyone can do it.
·
It will simulate live trading
mechanics: entering/exiting trades, using proper risk, etc.
·
No money at risk.
Even if you want to do automated trading, I believe that most people are
better off starting with manual back testing because it is easier to start and
you get a better feel for a system.
PROS
·
It can be time consuming.
·
No guarantee that it will work in live
trading, it has to be forward tested also.
·
You need to be able to handle the
drawdowns.
·
You need to be able to follow a set
of rules during your testing. If you keep changing your rules in the middle of
a test, you will not get accurate results.
Now that you understand automated and manual back testing, it's time to
decide which one is best for you. I
would recommend choosing just one and becoming and expert at it.
Now how to back test
for free
We live in a great time. Technology is getting better and cheaper. So if
you have a very limited budget, then I have some great news!
You can start back testing for free. Here are the simplest ways that I
would recommend getting started.
If manual trading and testing is your thing, then I would recommend starting
with due to how easy it is to get started.
Metatrader 4 is also free, but you have to install it and there can be
some trouble with getting it to work right, especially on Mac or Linux. So
start with Trading View and see if it works for you.
Setup a risk calculator to help you compute lot size when opening a
trade. This will ensure that you are not risking too much on each trade.
Now scroll the Trading View chart back to the point when you want to
start back testing. Add any necessary indicators.
Then hit the right arrow on your keyboard to advance the chart
candle-by-candle. Enter your trades on the spread sheet.
Once you are done back testing, you are ready to analyse your results
WHAT IS THE BEST WAY TO GET STARTED WITH PROFESSIONAL FOREX BACKTESTING?
Free options are great, but when you are ready to get real, then you
will have to spend some money. This will save you a ton of time and headache.
Don't worry; it doesn't have to be a lot of money.
Forex Tester looks like MT4, so it is easy to use. You will still
want to create a risk management spread sheet, so you calculate your risk and
lots per trade.
Forex Tester can be used for automated back testing, but I have found
that it is hard to find programmers who can code for it. So stick to it for
manual back testing only.
Conclusion
That is how to get started with Forex back testing. I hope that I
have cleared up any confusion that you may have had.
Test often and you should start to see the benefits.
I firmly believe that the only habits you will stick to are the ones
that are easy to do. So make back testing as easy as possible and it is a
habit that you will keep doing.
Make no mistake, this will be work. But almost everything worthwhile is
Got any more questions or advice please about back testing? Leave them
in the comments below…
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