Your success rate as a forex trader is heavily dependent on the strategy that you choose for navigating the volatile market. Learning about different types of strategies and finding the right strategy for yourself is a time-consuming process. After that, you will have to tailor it based on your personal preferences and risk appetite. But how can you be sure about the strategy that you have selected or devised after all this research? Will you be able to pull it off in the actual trading process? How can you know if the strategy is good enough to get the results you want or if there is more work to do to make it viable?
You can find answers to all these questions by backtesting your strategy on a trading platform like MT4 or MT5. MT5 does offer more backtesting statistics in comparison to its predecessor and you can also use more time frames which are not there on MT4. It also allows multi-currency backtesting and will be suitable for multi-asset trading as well. You can download the platform software on your PC, Mac or smartphone.
Irrespective of the platform you use, the process of backtesting is essential and I will be sharing some valuable information about the same in this blog.
Basics of Backtesting In Forex Trading
The only way to evaluate the efficiency of a strategy is to try it out on your own but risking real money for the sake of testing will not be an ideal method. Hence, trading platforms offer backtesting tools that can be used to assess the performance of your strategy without any risk. The backtesting is done by using historical price data for executing trades and you get to see the results right away.
You can either backtest your strategies manually by placing the trades yourself or automate the process. This way, you can test both manual and automated strategies. In the case of MetaTrader platforms, you get a strategy tester tool for automated backtesting and you can easily test your EAs and also optimise them to get better results.
Benefits of Backtesting
- Check the accuracy of the strategy – Backtesting shows you the actual results that you would have gotten if the strategy had been executed in the past. This allows you to check the accuracy of your strategy in different market situations and MT5 backtesting even considers scenarios like delayed execution which often happen in live trading.
- Risk identification – Backtesting also reveals the risks that are involved in implementing a strategy which is useful for devising your risk management plan. Having a sound risk management plan is essential to overcome the weaknesses of your strategy.
- Gain more knowledge – Another benefit of backtesting is that it allows you to gain more knowledge about the market as you will be going through historical price data when you are placing trades manually. This prepares you to stay flexible and adapt to the changes in market situations as and when needed.
- Instant results – When you test your strategy on a demo account, it takes more time as you will have to wait for the market to move in real time. Since backtesting is done using historical market data, you can get instant results which saves a lot of time especially when you are testing long-term strategies.
- Strategy Optimisation – The key purpose of backtesting is to fix the shortcomings of your strategy and optimise your trading system to get the best possible results. Besides this, refining your strategies also boosts your confidence as a trader leading to better performance.
Different Types of Forex Backtesting
- Manual backtesting – In manual backtesting, you will have to find trading opportunities by manually analysing the market situation and placing orders manually. Manual backtesting does take a lot of time but it also helps in enhancing your skills as you gain some experience in entering and exiting trades.
- Automated backtesting – Just as the name suggests, the backtesting process can be completely automated in automated backtesting saving you time and effort. It is perfect for testing your trading bots or EAs to check their performance.
- Monte Carlo simulation – For this type of backtesting, random market data will be chosen which allows you to evaluate the performance of your strategy under diverse market conditions.
- Walk-forward analysis – This type of backtesting is done to check the adaptability and flexibility of your strategy by testing it across distinct data subsets.
- Out-of-sample testing – This type of backtesting is done to ensure the robustness of your strategy by using a different set of data that you haven’t seen before.
Steps to Optimise Your Forex Trading Strategy
Once you get the results from backtesting, you can modify it or make some adjustments to refine it further. This is what we refer to as optimisation and it involves various steps that can fine-tune the strategy to maximise profit potential and minimise the risk of getting the desired results in live trading.
- Reviewing backtesting results – The first step for optimising your strategy is reviewing the backtesting results to identify the strengths and weaknesses of your trading system. Because optimisation is about making the best use of your strategy and for that you need to understand what it lacks and how to fix it.
- Choosing suitable indicators – The next step is to choose some suitable indicators that you can rely on to make the decision-making process easier while following your strategy. When you see a lot of information on the price chart, finding ideal trade setups will be harder. But when you add some indicators to the chart, you will be able to decide the best entry and exit points with precision.
- Adjust Take Profit and Stop Loss levels – The next step is to make adjustments to the Take Profit and Stop Loss levels. This is important to lock your profits after you win a trade and cut the losing trades right away. One tool that you can use for setting the target profit for trades is a profit calculator that tells you the potential gains of a trade based on the data you enter. Trading calculators are very accurate and easy to use. You can find different types of Forex calculators for daily calculations of different trading values.
- Use optimisation tools – The MetaTrader platforms also provide powerful tools for optimising your strategy. You should also consider the level of risk that the strategy has and take measures to minimise it. At the same time, you need to maximise the profit potential and work on making the strategy sustainable for long-term success.
One thing to keep in mind while working on strategy optimization is to keep things simple as a complex strategy will only make the trading process harder. Don’t try to make it perfectly fit with the past market situation as the current market scenario will be different.
Final Words
In a nutshell, your strategy is the foundation upon which you will be building your trading career in the forex market and backtesting is a process to make sure that the foundation is strong enough for attaining success. You should continue to evaluate and refine the strategy even after going live as there is always room for improvement and being disciplined is paramount.
