Backtesting is crucial for Forex traders, both for newcomers and experienced traders. This especially concerns those who do automated trading. Finding a proper strategy might be a good start, but having it tested in real market environment is much more important. You can check how well the strategy that you are applying performs by testing it either manually — which is a long and sometimes confusing process — or by using particular software that helps you do this automatically. If you are looking for the ways to measure performance of your strategy with specialised software, this article is for you. We will lead you through the basics and to the specifics of using the FX backtesting software.
Forex strategy backtesting works in the following way: users simulate strategies applied to the past trading data and generate reports that analyse the performance. Software normally varies by its capacities regarding the number of simulations that can be run, time frames and types of data that can be chosen, and the ability to revise the tests by saving them. The best Forex backtesting software allows users to run multiple simulations on diverse data in the the time frames that they choose.
In simpler words, Forex backtesting will help traders decide whether their chosen strategies are working or not. In any case, one should be aware of the fact that backtesting results may still vary from the results of real-life trading. There is a number of reasons behind that. For example, there is no computer which can predict irregular human behavior; and the latter appears to be a significant factor in trading operations, especially when money is one's focus of concern.
It is important to use such Forex backtesting software which can provide you with the same set of tools that you would normally use in trading live, such as certain time frames or graphical charts. A number of applications is also capable of exporting and analysing your data log.
FX backtesting can be very helpful for both first-timers and experienced traders. For a start, beginners can make use of backtesting for the purpose of learning. It gives them a chance to make trials and errors without having real money at stake. At the same time, advanced traders will benefit from it by inventing new strategies and testing them in practice with no risks involved.
Backtesting allows users to see what the result of using their trading strategy would have turned out in the past, whether they test it with last year's data or last week's. Every trader should bear in mind the fact that a strategy can work well at a particular time and under certain circumstances, while it will be useless at other times. For example, traders know how dramatically news can change the market and, respectively, the way a chosen strategy works. It is beyond one's capability to predict the extent to which news will affect the situation on the market.
All in all, Forex strategy backtesting will provide you with some hints on what would be applicable at some point in the future.
First of all, Forex backtesting software will help you determine the best time for running your trading strategy or give you a signal on when to use another one. This will allow you to better plan your trading activities, in order to achieve the desired results in the shortest time span, up to a few hours a day. Nevertheless, Forex backtesting may not be enough for you to be 100% sure in the success of your trading strategy. It is advised to do some forward-testing the as well, for example, by trading in a demo mode or trading smaller amounts of money. This will not only help you test your strategy fully, but will point out the areas in which the strategy should be modified, in order to avoid potential financial losses.
Backtesting helps you to try out your strategies over the longer periods of time. Due to a special optimisation feature, FX backtesting software is preferable, as it offers a historical chart that allows seeing the best-performing settings. While the performance of the backtesting software undergoes constant discussions and is a subject of debate, and while it provides traders with only approximate calculations on the effectiveness of their chosen strategies in particular environments, the software like this is the best instrument to use when one wants to quick-test a strategy against a range of trading options.
Forex software for backtesting comes at hand to traders when they are deciding on which strategies to use in order to profit. A vast majority of them see the software as a universal tool which, in most cases, saves the day's earnings.
The main feature of the best Forex backtesting software is that it simulates real-life trading and allows users to evaluate their strategies of choice quite accurately.
A number of tools are available to traders designed specifically for backtesting their strategies. There is a large choice of software types, of which some are free, while others are paid. Besides, there is a number of brokers who offer such software.
Manual backtesting wins by certain criteria. Just to name one, the only tool you will need is the price chart. Still, the disadvantages of this method include the abovementioned human factor (and a great chance of error) and a huge amount of time. It is, however, often recommended to beginners who can see how their strategy works right on the spot and can come up with the ways of improving it almost immediately.
The main rule of manual backtesting is to clarify the rules by which you are going to trade. What does this mean? You need to specify the points of entry and exit, stop-losses and take-profits values, and just about anything else you will need according to the strategy you have chosen.
Once you've done with all of the above, you should get ready with your chart. Think of all the tools like graphical objects and indicators that you will normally use in your strategy and apply them to the chart. Then, you should scroll back the chart at least to the point of one year ago. After that, simply try to simulate the strategy of your choice, while paying significant attention to the smallest details. A position should be opened at the time when you spot the scenario which coincides with your entry point; a similar thing should be done when you are closing the trade. You can use Excel for some of that.
On the one hand, such a routine will consume a lot of your time. On the other hand, it will give you a good understanding of how your strategy normally performs and how it will do so in the future. Besides, it will provide you with some clues on how you can improve it further. Traders who are learning are encouraged to use manual backtesting rather than backtesting software.
Sometimes, the most regular software for traders, such as MetaTrader 4, will provide you with a good opportunity to backtest your strategies. In order to get started, you will be required to install it on your computer. In case you aren't acquainted with MT4, you can request a demo account and use a trial version.
If you are a registered user, you can launch the Strategy Tester in the MT4 pack right away. Just go to the software's View menu or access Strategy Tester by clicking the proper button.
You will need to have a history of price ticks for the period when you want to backtest your strategy. You should have a 2-year history if you are going to check the performance of your strategy over the last couple of years. Do not worry if you are not keeping history; Admiral Markets have all the logs and will be able to give them to you.
If you are going to use the M5 time frame to test your strategy, then you should select it in Strategy Tester after making sure you have the history for this time frame complete.
A pleasant bonus of using Strategy Tester with MetaTrader 4 is that it provides an optimisation possibility. Apart from backtesting, you will also get your strategy analysed and criticised, which will help you to develop and use its improved version (or a totally different one) in the future.
Once you have specified the rules which apply to backtesting of your FX strategy, you will get a fully customised feedback provided by MetaTrader 4, which will include your trading result, the balance between your gains and losses, data on drawdown, and number of trades where you profited. What's even better, MetaTrader 4 will provide you with some recommendations on how accurate the output is and how likely it is to change if the conditions vary, even if just slightly.