What are the Best Tips for Forex Backtesting?

Justin Riche
Justin Riche
Man climbing a rope
Man climbing a rope

A trader seeking to test a new trading system should ideally use forex backtesting software. The best software should allow the trader the flexibility to easily load up historical data, set up charts as preferred, use multiple time frames, save tests and revise them and more. The trader needs to understand that there are various factors that will likely cause a discrepancy between backtesting performance and actual strategy performance in live trading situations. Therefore, the trader needs to err on the side of caution and employ appropriate risk-managed trading methods both while backtesting and trading live.

A foreign exchange trader can purchase a software simply dedicated to forex backtesting. Alternatively, the trader can avoid the unnecessary cost by using one provided by a forex broker he or she currently uses or intends to use, because most of them provide trading platforms that permit forex backtesting. The automated software means that the taxing manual approach practiced by some traders doesn't need to be used. The trader needs to ensure that the software has all of the features he or she intends to use in live trading, such as different time frames and various kinds of charts.

The trader can choose to utilize either fundamental or technical analysis, or even both, while backtesting his or her strategy. Fundamentally, for example, the trader can decide to sell the US Dollar whenever the U.S. Federal Reserve cuts interest rates or pumps more money into the economy, because the currency likely will lose value as a result. Technically, for example, in a strong uptrend whenever a pair, such as the US Dollar versus Swiss Franc, pulls back and reaches the 10-day moving average, the trader can place a buy order as soon as it resumes ascending.

He or she also must be wary of the sentiment and behavior of the market and its capricious propensity. This erratic tendency of the market can often invalidate some of the aspects of the investor's backtested trading strategy. This is why he or she should keep the strategy flexible and open to appropriate adjustments. Additionally, managing risk is strongly advised and can possibly be achieved by getting into the habit of using stop losses and take-profit targets. Moreover, the investor should not risk a significant amount of his or her trading capital. Generally, risking more than 3 percent of the money in the trading account can eventually have detrimental effects.

When carrying out forex backtesting, a trader's disposition might differ from when he or she is trading live. This can potentially produce inauspicious results, in a live situation, because the trader's psychology is susceptible to irrational decision making when real money is at stake. Therefore, the investor should therefore develop self-awareness, and then work on reining in his or her emotions. This will allow him or her to observe the market with a dispassionate eye and behave as consistently as possible in both situations.

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