Think about this, before you sign up to a trading academy or join a forex trading signal group, you usually would do a research about the trader or academy by observing them through checking their Youtube pages, Instagram accounts, Trustpilot, telegram channels, reviews from their clients, chatting with their support team, visiting their physical office and getting other relevant information about them.
This also applies to other products or services you buy, right?. The reason you do this is so that you can check if it is worth your time and money. This product research you do is what is known as BACKTESTING in the Forex market.
When you come to the Forex market, before you put your hard earned money on the line, it is important you do a research through backtesting.
Some traders may decide not to backtest but they may choose to test their trading strategy in the live market in a forward moving pattern. And while they do so, they observe and record the outcome.
It is however, still very much advisable to do a thorough backtesting of your trading strategy before trading it live.
To backtest effectively, you need a solid trading strategy.
There are different approaches to trading the market. A writer once said that there are many ways to kill a rat. So it is in the forex market.
You can learn a trading strategy by checking through the course for different trading styles (both retail and smart money concepts) or you could develop your own trading strategy from the markets.
You cannot be trading without knowing if your trading style is profitable or not. It’s just like going to the war front without knowing the right weapon to go with because you have not taken the time to test the weapons. Your opponent will most likely ruin you. Even if you have the right weapons, you still need to test it, that way, you understand how it works and you can effectively use it and become more skillful in its application.
Backtesting is important for 2 main reasons.
1. You need to know whether your trading strategy has got an edge in the marktets. Your strategy should be able to tell you if it is profitable or not.
If it was profitable in the past, it is more likely to continue being profitable until otherwise proven. If it has a poor success rate then you will need to do away with it.
Let me ask you a simple question? What is the win rate of the strategy you are currently trading? Please drop your answer in the comment section.
If you’re trading with no idea of what your strategy win rate is, then you are going in the wrong direction and you need to retrace your footsteps before things get worse.
2. You need to know how your strategy performs in different market phases/seasons. Good knowledge about the metrics of your strategy (winning trades, losing trades,drawdown, profit factor, and other important pointers) is a determinant factor in getting to measure the performance of your strategy.
How to backtest like a Pro
1. Have a trading strategy; develop a detailed and well defined strategy. This will include trading sessions, risk management rules, entry signals, entry and exit levels and other necessary data, indicator type and other relevant information.
Example of backtesting
A trader could learn a strategy that says,
Use the 200 ema on the 4hr chart to buy when it is below the current market price and sell when it is above the current market price. Then he collates data from previous years, let’s say from year 2017-2022 to test it and see how it worked in the past.
2. Select a backtesting platform to use; there are quite a number of backtesting platforms that allow traders to check through historical data for their backtesting analysis. Platforms like Trading view, Forex Taster, Meta trader and others. Some of these platforms offer free trials while some would require that you subscribe with a token to access their historical data.
3. Select the currency pair(s) you wish to backtest;
There are over 28 currency pairs. You cannot possibly be trading them all at the same time. Choose currency pairs that have the most volatility. You can check out this post on how to select the best currency pair to trade.
4. Gather your technical indicators and add them
After you must have learned or developed your strategy, use the parameters you set in your plan and include them on the trading platform you are using. Learn how to trade and develop a strategy that is suitable to you
5. Select the historical data you wish to use
Select what trading period you would like to backtest on. For example, using your strategy, you could decide to backtest the EURUSD between the year 2020-2022
4. Journal the results
It is advisable to have handy your trading rules written in your journal. If a trade set up checks all the boxes on your trading plan, take the trade, observe the outcome and record it on your journal. You can only measure progress when you take record.
Benefits of backtesting
1. You can tell if your trading strategy is profitable or not
2. You become more confident in executing your trades
3. You become more disciplined and wait for the market to present your trading set up.
4. You can confidently share your trading knowledge with others who may be struggling with finding a trading strategy.
5. Your trading psychology is improved and you become a more professional and profitable trader.
It is advisable to have a record of at least a 100 trades that you have taken with the strategy. This will help you effectively determine the win rate. If the ratio of wins and losses is 60;30, it means that the strategy is profitable. You won’t be bothered when the losses come because you know that your trading style is still profitable in the long run.
If you found this helpful, please share your thought on this in the comments. If you have further questions, kindly contact me here