How To Effectively Backtest A Forex Trading System

Backtesting plays a very important role in forex trading because whenever you want to test out a new forex system or strategy, you will obviously want to test it out and see how it performs. This will involve going back over weeks, months, or even years of data, and can be quite labour intensive. So what are the best ways to backtest your systems?

Well a popular way to backtest forex strategies is to use software of some kind. Many charting packages can now be programmed with certain trading criteria, so it can be very easy to do this. You simply enter the specific technical indicators that your system uses and enter the trading parameters that signal the opening and closing of a trade (as well as the stop loss and profit targets). Then you should hopefully be given a full historical record of the overall success rate, and therefore profitability of your system.

Software definitely makes the whole backtesting process a very quick and easy one, but I personally prefer manually backtesting because this will give you a more realistic expectation of the kind of results you can achieve.

For example, when you are trading yourself there are often a lot of emotions involved. You are not a robot. There are often strong decisions that need to be made before entering a position, even if you use the exact same system every single time.

This is something that is easier to detect when manually looking through historical graphs because you will see certain set-ups that are more likely to be winning trades than others, whereas software will simply track the results of every single trade. Also when you manually look through price charts you will get a very good idea of what kind of profit targets can be achieved on average, and how wide your stop loss should be if you want to maximize your overall profits.

The key to a successful system is that it generates consistent profits on a long-term basis. So therefore I always believe that you need to analyze several months of data at the very least because market conditions can quickly change. A system that is profitable at the moment may not be profitable in six or twelve months time, for instance.

So always carry out extensive backtesting when testing out any new system or strategy, whether you do it manually or through a software program. You want to ensure that your system is profitable before you start trading with real money.

Finally for further success I would recommend you do at least part of your backtesting manually because this will enable you to quickly identify which kind of set-ups are the most profitable, and will give you an idea of how big or small your stop loss and profit targets should be.