Ten Essential Forex Backtesting Rules

Here are the ten Forex backtesting points that are essential to your forex backtesting strategy:

  • Make sure that the historical data goes back far enough to provide accurate testing results under a variety of market conditions. If your data extends back only through the latest bull market, you won’t know how the system will perform in a bear market.
  • Before starting the backtesting process, check and double-check your historical data to make sure that it accurately represents real-world trading scenarios of the type that your system is supposed to handle.
  • Always include “out of sample” data. That is data other than the data which was used to build the system to begin with. Otherwise, you will be only testing data that already produces results matching your system’s strategy.
  • If you specialize in trading specific currency pairs, make sure that your data covers those pairs. But for best results, and to allow you enough flexibility to trade additional currency pairs in the future, use as broad a range of test data as possible.
  • Also, to the extent possible, try to utilize historical data that reflects both positive and negative world conditions. With the market so easily affected by terrorism, fluctuating oil prices and political unrest, you need to know how your system performs when the world is facing a crisis as well as how it functions in time of relative serenity.
  • Make sure that your data models provide for a realistic amount of slippage, especially during volatile and fast-moving market conditions when you can be sure that some slippage will occur.
  • Make capital management part of your backtesting strategy. After all, the idea is to earn a profit at the end of it all. It makes no sense to backtest years of trade data if, in real life, you would have run out of money to invest had you followed the trading system’s recommendations.
  • Be sceptical. If your backtesting results show that you have developed the ultimate fail-proof trading system, don’t believe it. Nothing is foolproof. The chances are there is a flaw in your data, or in your testing methodology, so start over.
  • If you don’t have the patience or skills to manually backtest your trading system use commercially available backtesting software.

Regardless of how good your backtesting results are, don’t forget what I wrote at the top of this article: “Past performance does not guarantee future results!”

Backtesting is a key part of developing and using a forex trading system. It is not a process to be skipped or taken lightly. If you do not have the mental discipline to backtest your trading system, it is likely that you do not have the mental discipline to use and stick to a trading system.