What is Backtesting Forex Trading Strategy

Have you ever wished you could go back in time and prepare for some unexpected conditions? Well, in Forex, you can at some point. Technically, it’s more like a super-realistic rehearsal before trading on your live account.

Forex trading can be a challenging and unpredictable landscape, requiring traders to develop and refine effective strategies, applying in-depth market research and well-thought-out tactics to navigate the market successfully. One critical method traders employ to test their methods before putting them into action is backtesting. Traders can practice their trading strategies in a simulated environment before using them in the real market.

In this article, we will examine the concept of backtesting, its role in Forex trading, how it can enhance trading performance, and what kinds of simulation techniques and resources are available to traders in their pursuit of success.

 

Most Popular Trading Strategies for Backtesting

1. Ichimoku EA

It is based on an Ichimoku Kinko Hyo trend indicator. This EA involves Tenkan-Sen and Kijun-Sen Bullish/Bearish cross. The price line is located above/below/inside the Cloud.

2. Stochastic EA

It is suitable for day traders. This EA is based on the crossover between the signal lines of the Stochastic indicator and the location of the Bearish/Bullish cross in the Oversold/Overbought levels. It allows you to spot the market turning points accurately.

3. 21 RSI + 5 EMA + 12 EMA

A pretty quick strategy. The head point is that the RSI Forex Indicator activates at the moment when 5 EMA crosses 12 EMA. When the crossing is upside, it is an uptrend; when it is downside — a downtrend. If the RSI Forex Indicator is above 50 during an uptrend — it is a signal to buy. When it is below 50 during a downtrend — sell.

4. ADX + RSI

Based on the Relative Strength Indicator (RSI). The mark under 30 means that the market is oversold. If it is above 70, the market is overbought. The difference between RSI and the price depicts the trend movement. Meanwhile, the ADX indicator identifies the trend strength. The preferable timeframe is from M5 to H1.

5. BullDozer

The strategy uses the exponential weighting method and exponential trading average with a 70 period to spot the trend. Awesome Oscillator with standard parameters search for the entry point. When it gives the reverse signal, it is time to exit the trade.

6. Double Stochastic Strategy

This strategy involves two Stochastic indicators — (8, 5, 3) and (14, 7, 3). You should use both indicators to get more accurate entry points. Open a trade only after receiving approval from both indicators. Oversold is under level 20, and overbought is over 80.

7. Elder’s Momentum

This strategy involves Exponential Moving Average and Momentum Indicator. The opening signal exists when EMA crosses the price (Momentum Indicator is at level 100). The preferable timeframe is H1 or higher.

8. Envelopes + RSI

RSI indicates the trend direction. Long position entry: the chosen pair reaches the required lower level + RSI meets oversold conditions. Short position entry: the chosen asset reaches the required higher level + RSI meets overbought conditions. The preferable timeframe is H1.

9. Force Index indicator

Force Index Indicator estimates the strength of the price movements and creates signals of potential price fluctuations. The system uses three other indicators: Moving Average, Parabolic SAR, and MACD. The preferable timeframe is M30 or higher.

10. Golden Cross + Death Cross

When fast and slow exponential moving averages are crossed below the price, it is the Golden Cross, giving a signal for the short position entry. If this crossing happens above the price, it is the Death Cross with the long position entry.

11. Kumo Breakout

This strategy for Ichimoku traders focuses on the price position relative to the prevailing Kumo. Additionally, the Awesome Oscillator with default settings is also involved. The EA works on multiple timeframes, but the most preferable is M15.

12. OSMA + MA

This strategy works when two SMAs are crossed, while OSMA signalizes the crossover of the zero lines. All timeframes suit well, but H1 is the most suitable one.

13. MACD EA

It uses MACD as a signal. This EA opens a sell trade when the MACD value is positive on the current candle. The MACD value of the previous candle was less than the MACD signal. The MACD value of 2 candles back is greater than the MACD signal.

14. MACD + MA EA

This strategy is based on the price line location relative to the SMA and the bullish/bearish crossover of the MACD signal lines.

15. RVI + RSI

RVI catches the changes in the market trends monitoring oversold and overbought areas, while RSI maintains the signals with the crossover of the lines in the same space.

16. Awesome EA

When the Awesome Oscillator histogram and the bar color are forming to break the zero levels.

 

What Are the Odds of Finding a Profitable Forex Strategy on the Internet?

The practice shows that the answer might be disappointing.
What makes the difference between a lucky guess and profound trading? Are you sure your trading style is more than just flipping a coin and expecting a positive outcome?

Or you are probably overwhelmed by the number of online trading strategies promising to bring a fortune. Want to know how to avoid desperate confusion when the “simple” systems only drain your live trading account?

Find the reasons why backtesting became the only reasonable way to trade smart. Please keep reading to learn how it is easy to confirm or disprove any trading theory with the power of backtesting and elementary school math.

We’ll focus on a series of backtesting experiments with one aim — to show traders (both beginners and professionals) that you shouldn’t take anything on trust, especially if you risk real money, and you should double-check ANY information found on the Internet related to trading.

We will not teach you the importance of technical analysis, but the math calculations speak for themselves.

 

What is Backtesting a Forex Trading Strategy?

Foreseeing how a trading method would have fared in actual market circumstances, backtesting allows traders to examine that method’s potential results. Backtesting software allows traders to explore their practices and improve based on historical data. A trading simulation aims to find flaws in a strategy and improve it to generate a higher return on investment.

Simulating market conditions can backtest a trading strategy in the past. The goal is to evaluate the strategy’s efficacy on the premise that a strategy’s track record indicates its future success. To do so, traders run hypothetical trades using past price data and examine the outcomes to ascertain the strategy’s win rate, profit potential, and level of risk.

Right now, you can join the Beta testing program to get access and help to improve FTO.

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Why is Backtesting Important?

There are several reasons why backtesting trading strategies is so essential. The first thing it does is support traders in finding any weak points in their methods. Traders can assess a system’s viability in various scenarios by testing it against historical data. To fix any flaws in their trading system, traders can now easily see them.
Second, the simulation process might increase traders’ confidence in their strategy. Traders forecast a system’s future performance by simulating it using previous data. This helps traders feel safe enough in their approach to use it in real-world Forex market.

Last but not least, backtesting aids traders in gauging the success of their trading strategies. Traders can learn whether a system is profitable by testing it on existing data and then fine-tuning it based on the results.

Backtesting trading strategies builds up the confidence among traders about the success of the designed strategy before implementing it 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 widespread usage possibilities.

 

When and How Should You Backtest a Trading Strategy?

There are specific measures that traders must take while backtesting trading strategies. One of the first things they must do is determine the parameters of their trading system. The parameters include the entry and exit points and the stop-loss and take-profit levels.

The next step for traders is to compile data on the chosen currency pair’s past performance. The open, high, low, and close prices for each day under consideration should all be included.

After accumulating this information, traders enter the rules of a trading strategy into a strategy tester and see how well it performs under simulated market conditions. The system rules and past data will be used to model the outcomes of trading positions.

After the simulation phase, traders assess their strategy’s efficacy. The only essential parameters that must be analyzed are the win rate, profit factor, and maximum drawdown. Traders then optimize their systems using the data gleaned from the simulation app.

 

Backtesting Steps

Investors take a few standard procedures to backtest a trading strategy. They start by picking a horizon for the simulation and a set of the Forex market indicators to examine. Such information includes pricing records, fundamental events, and similar records. The next step is for the trader to enter their trading strategy into a backtesting software tool, which uses the method and historical data to generate simulated trades.

Forex Tester is one of the best trading simulation software products available in the industry nowadays. The app is user-friendly and has dozens of useful functions with different approaches in the trading simulation.

 

5-Steps Plan to Score the Best Results While Backtesting Strategies

You will totally agree that:
It would be easy to perform a simple backtest as depicted above. Nevertheless, to get deeper into the topic, we included some math to make the experiment results more illustrative.

No boring math, don’t be afraid.

What is the reason behind such a complex approach?

The following calculations help to save your precious time and effort and bring up the entire backtesting process to a new, more precise level.

How can the trading strategy work under the pressure of the various market conditions? We solve this issue quickly with the idea of the Training Set and Forward Testing.

We performed several experiments to increase efficiency within the historical data’s short period and compared the results.

The entire process will take 5 STEPS:

1. We defined periods of the market when it was mainly Bullish, Bearish, and Flat. As for the Bull market, we take the period from 14/02/2011 to 25/04/2011. The Bear market refers to 18/08/2014-19/01/2015. The Flat market continued from 15/08/2016 until 03/10/2016.
2. We test the chosen strategy within the conditions of the Bull market and enter 50 trades — this is how we form the Training Set; next, we perform the same backtesting for the Bear and Flat markets within the range of the dates above (again 50 trades at each);
3. To perform Forward Testing, we define more periods of the same three markets:
   a) Bull market — 09/06/2010-01/11/2010
   b) Bear — 01/09/2011-16/07/2012
   c) Flat — 04/05/2015-12/10/2015
4. Then we enter the 20 trades at each of the markets, creating the Forward Testing set this way.
5. The last but most crucial step — with a sense of accomplishment we compare the results and make conclusions.

 

Disclaimer: it is impossible to test all the variations of the strategies, theories, and trading ideas — there are tons of them. If you have not found the method you are currently interested in among the ones we have backtested, feel free to backtest trading strategies yourself and share your opinion.

Moreover, we cannot guarantee the ideal performance of the Forex trading strategy during the live trading, even if it turns out to be profitable during the backtesting.
The backtesting gives you statistically proven confidence in your trading decisions to some extent. However, we sincerely believe that without it, trading becomes a synonym for gambling or a lucky shot in the dark.

Please remember that you use the backtested Forex strategy on a live trading account at your own risk.

 

Analyze the Results

Traders may evaluate the backtesting outcomes and make any improvements to their trading strategy. The entry and exit positions, stop-loss levels, currency pair, and other Forex trading strategy elements may need to be modified. To improve their decisions in real financial markets, traders may learn how their methods fared under varying market situations by first testing them on historical data.

How to Adjust Settings and Compare Results

You might be wondering:
If the backtesting experiment shows pessimistic results, should it be the reason to discard the trading strategy and search for the new one?

We pick the trading strategies with commonly used indicators, default settings, and suitable timeframes for experimental backtesting. However, as a trader, you understand that various settings, indicators, timeframes, and currency pairs give you endless opportunities to perform experiments.

What can be a matter of the additional change and backtesting within the strategies?

• Stop Loss and Take Profit — you can try to change them accordingly, increase or decrease, they can have equal meaning, or the riskiest ones can try to backtest a trading strategy without Stop Loss and Take Profit and close trades manually based on the signals from the indicators (however, we strongly do not recommend you are doing this);
• We use the default setting of indicators. However, you can backtest the custom settings — you never know what can work the best for a given currency pair;
• Timeframe and the currency pair: some trading approaches might work better on specified conditions;
• The entry points of the trade;

Very important: we set the spread meaning to 1 point during the backtesting sessions. Please check yours because the spread matters — the larger it is, the larger the profits you should have to cover the difference. Besides, trading conditions might vary from one broker to another, so Forex traders should match them within the strategy tester to get real trading costs.

The only reasonable way to learn the odds of earning money using ANY trading plan — is to put it to the test.

How to Read the Results?

What is the way to compare the results of the Training Set and the Forward Testing?
The main idea is that performing successfully during the 50 trades of the Bull market period, for example, a trading strategy usually will show mostly identical results during the Forward Testing.

As for calculations, we receive the Training Set results by dividing the profitable trades by the whole number of trades. The same way we get the results for the Forward Testing automatically. In contrast to paper trading, the simulation with the Forex Tester software provides instant results for in-depth analysis.

The numbers we receive should match more or less for satisfying results. Besides, we will check the periods in the strategy tester — any professional trader wants to recoup his investments within a shorter period.

 

Why is Backtesting Crucial in Forex Trading?

There are several reasons why backtesting is very important when trading Forex:

• Backtesting is a valuable tool for validating trading techniques before they are used in real life. As a result, traders may assess the strategy’s viability and profitability before committing to it.
• Risk Management: Forex traders may evaluate the potential loss associated with a specific system by looking at its past results.
• Trading simulation helps traders optimize their methods by revealing weak spots in their entry and exit locations, risk-reward ratios, and chart timeframes, among other areas. It would take much more time to backtest a trading strategy with paper trading on a demo account.
• Trading with confidence comes from knowing that your method has been thoroughly tested and has performed successfully under various market situations.

 

Types of Backtesting Methods

Three basic approaches exist for simulating historical market conditions while developing Forex trading strategies.

Manual backtesting

Manual backtesting requires the trader to manually examine price charts from the past and apply their trading method to those circumstances. While it is time-consuming and prone to human error, this approach may provide traders with valuable insight into the performance of their strategy and the market.

Trading simulation

The performance of a strategy may be evaluated by simulating real-world market situations in the past. Traders may determine the strengths and weaknesses of their approach by replicating historical market conditions.

In contrast to a traditional demo account with forward testing in real-time market conditions, this method allows traders to hone their Forex strategies and gain essential insights before risking real money in the live market, thereby improving their decision-making processes, increasing their chances of success, and saving them time.

Algorithmic backtesting

Backtesting a trading strategy automatically using dedicated software is known as algorithmic backtesting. The program allows traders to enter their strategy settings, generating hypothetical transactions based on past market activity. Although automated backtesting improves upon manual simulation in speed and accuracy, it may only consider real-world aspects that affect a strategy’s success and may need some familiarity with programming languages.

 

Tips for Effective Backtesting

Traders who want reliable backtesting results should stick to a few tried and true guidelines. Traders should first take advantage of reliable historical price data. This information must be complete and correct, including OHLC prices and tick data.

In addition, traders should only employ trustworthy backtesting software. The strategy tester should model transactions according to the system’s trading rules and past data.

Traders should only optimize their strategy based on simulation results. An over-optimized system may need to be simplified and easier to understand. Traders should implement a technique that has a slight learning curve compared to paper trading or a demo account, and produces consistent results.

 

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.

 

Try it Yourself with Forex Tester

Setting up a testing environment in Forex Tester is the first step to backtest Forex trading strategies. To do this, we must first import historical data for the selected currency pairings and periods, taking care to import only complete and accurate records. Traders may simulate their trading situations by importing relevant data and setting settings such as starting account balance, leverage, and other conditions. With the backtesting software’s intuitive interface, traders can easily adjust these parameters to simulate market conditions that are as realistic as possible before placing actual trades.

After setting up the Forex Tester software, traders may try their preferred trading method before committing to real money. This process includes using the required technical indicators, establishing entry and exit rules, and determining risk management parameters like stop-loss and take-profit levels.

As the software allows for creating custom indicators and a wide variety of pre-made ones, traders have a great deal of leeway in using Forex Tester for the trading strategy backtesting. Moreover, the program allows users to choose their preferred approach, whether manual backtesting or automated backtesting.

When traders set up their trading strategy, they may begin simulating it in Forex Tester. Traders may keep tabs on their transactions and examine their results in real time with the help of the software’s powerful visualization capabilities. Users may also alter the simulation speed to experiment with different tactics or examine individual market occurrences in more depth, both of which are available in Forex Tester.

After finishing the simulation, traders may fine-tune their trading methods for better profitability and decreased risk by reviewing comprehensive performance data and reports.

Final Word

A successful trading strategy can only be created by first being backtested. Any trading approach must first be tested using historical data to reveal flaws. Trading systems may be tested against historical data to assist traders in assessing their success. High-quality historical data, reliable backtesting tools, and avoiding over-optimization are all essential for successful simulations. Following these guidelines can create a successful forex trading strategy and confidently enter the financial markets.

Backtesting is an effective method for investors to improve their trading plans. The results of a backtest cannot be extrapolated to the future, but the knowledge and information gained may help guide trading choices in the real market.
Backtesting your strategies is the secret weapon in the thrilling world of forex trading. It’s the difference between shooting in the dark and hitting the bullseye.

And with Forex Tester by your side, you have the power to unlock this incredible advantage. So, why wait? Take control of your trading destiny and embark on a journey of success. Don’t let opportunities slip through your fingers.

Invest in Forex Tester today and join the ranks of savvy traders who understand the importance of backtesting. Start making informed decisions, and fell the satisfaction of watching your profits soar. Take the plunge and seize this opportunity to become a master of forex trading. Buy Forex Tester now. Your future self will thank you.

 

FAQ

 

What does backtesting mean in forex?

Back testing is a way to confirm that the EA or trading system you intend to use actually does what it intend or seems to be. Nevertheless, your Forex trading system will become pointless if it can’t perform the way you thought it was going to.

However, you will also need to know that your Forex trading systems are going to work under many diverse conditions and not let you down at crucial moments.

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.

 

What are the benefits of backtesting in forex?

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.

 

What are the risks of backtesting?

• Historical data may not accurately predict future market behavior, meaning no strategy can guarantee precise results.
• There’s a risk of overfitting a model to historical data, potentially overlooking how future conditions might differ.
• Historical data can be biased by unusual market events or unusually positive sentiment.
• Limited datasets might result in models that don’t account for diverse market conditions.
• A strategy that performs well in one market (e.g., forex) might not be effective in another (e.g., stocks).
• Strategies that perform well in a bullish market might not work in a bearish market, and vice versa.