Backtesting

Forex Backtesting vs. Forex live trading:
main points to know

Backtesting Explained

Backtesting is a trading strategy based on historical forex data. It plays a vital role in determining whether a strategy works or not. In backtesting trading strategy, instead of working in the future period, a trader can simulate on the past data in order to measure its effectiveness. It is very popular strategy amongst traders because of its easy and straightforward approach. Traders who apply this technique believe that past performance is indicative of future results.


Benefits

Backtesting strategy is used to test the technical analysis of various strategies to be applied in forex. By using backtesting a trader can test the workability of a given strategy and can thus check whether similar results would have been achieved as achieved in the past. Once you have the past results and results achieved after backtesting, you can compare and determine whether the strategy has predictive value or not. It is very common among technical traders and most of the trading is done on computers. The digitalization era has made the task easier and less complicated.

Backtesting trading strategies builds up the confidence among traders about the success of the designed strategy before implementing in the current market scenario. It is based on the notion that if a strategy has proven itself right in the past then it will work successfully in the future as well and vice versa. Nearly anything can be back tested, so backtesting has wide spread usage possibilities.


Points to be considered before backtesting

There are few key points, which should be considered before starting with the process of backtesting.

  • Past results may not apply to future
    Since backtesting is based on past information, the results achieved in the past may not necessarily hold true in the future too. The forex market is volatile and can change anytime which can affect the performance of results derived using backtesting.
  • The results are not exact
    In a forex market, there are many variables affecting the process of backtesting. Use of different spreads by different traders may alter the results. The volatility of market conditions also affects the results because even upon using same strategy in two different market scenarios will generate different results. Another factor affecting the outcome of applying backtesting is whether it is performed by a human himself or is done algorithmically. Using algorithmic method will definitely produce fewer errors as compared to the testing performed by human.
  • Working live is different
    Working live in the present market conditions is different from working with the past data. There is a possibility either of the trader reacting too slowly or of committing mistakes in order to catch up with the current market environment.
  • Trading large
    Trading large amounts can yield different results each time. In addition, when a trader goes in for larger volumes, there is a chance of moving the price of the given currency simply when the order is placed.
Despite the problems, backtesting can be used as a powerful tool by a trader.