Forex Back Testing

Back testing a Forex Trading System

One you have identified one or more potential FX trading systems that you are interested in using, or even if you are you are working on developing a trading system on your own, it is critical that you take the time and effort necessary to perform thorough backtesting.

Backtesting is the act of verifying that the system actually performs as expected under diverse market conditions so you can be confident that it will not let you down when you need it the most. If you fail to backtest a trading system you will not have the confidence to do what the system is telling you to do when your instinct is telling you to do something else instead.

Backtesting a trading system involves actually executing that system against historical market data and analysing the trades you would have made according to your system’s strategies.

Backtesting in this manner not only uncovers any hidden flaws in the system, but it also gives you the ability to hone the system’s performance until it is the best that it can be.

Not only is it important that you never skip the system backtesting process, it is also important that you spend all of the time necessary to do the job right. This can be time-consuming depending upon the complexity of the trading system you are thinking about using and the amount of historical data you will be analysing.

However, no matter how thorough, complete and accurate your backtesting strategy is, you should never forget the #1 rule of trading:

“Past performance does not guarantee future results!”

Here are some of the vital statistics that play a part when backtesting your FX trading system:

  • Net Profit/Loss for the defined testing period
  • Historical data date range
  • Universe Currencies included in the dataset
  • Volatility
  • Average gains and losses as a percentage of total trades
  • Amount of capital exposed to risk
  • Win vs. Loss Ratios
  • Annualized returns
  • Risk-adjusted returns