Backtesting Your Forex Trading System – Some Key Points to Consider

Many forex traders, including myself, spend hours on end testing out new forex systems and strategies. We may buy a system or discover a profitable strategy on one of the trading forums, for example, or we may devise our own system from scratch. Either way we will always want to do extensive backtesting to see if the system is actually profitable or not, so here are some key points to consider.

Firstly you have to realize the importance of backtesting. You can not stumble upon what appears to be a profitable trading method and start trading it immediately with your own money. This is complete madness. You need to test out this system going back several weeks and months and see how it performs to find out if it could actually make you money.

A key point about backtesting is that you have to look at price charts and try out different stop losses and price targets. It's very easy to look at historical data and take the best case scenario as proof that your system is profitable, whereas in reality you will very rarely close out a position at the best price possible.

So if you are testing out a system that uses a stop loss of 20 points, for example, and a target price of 50 points, make sure you apply these limits when analyzing historical results. You have to think about how you would have traded if you were using that particular trading method at that time.

You can always alter these limits to maximize your profits. For instance if you find that the price will very often move much more than 50 points, then you may decide to test out a higher target price or you could close out half the position for 50 points and let the other half run, for example.

The key is to keep doing backtests as far back as possible in order to devise a system that is as profitable as it possibly can be. You need to test out at least several months of data because systems can be profitable for a time and then become unprofitable when market conditions change.

One other point you should consider when backtesting is the spread. This factor is often forgotten about but you do need to take it into consideration, particularly if many of the trades happen just after important economic data has been released. During this time the spread will typically be widened so if your system is only just profitable, you may find the widened spread at certain times may be enough to make it unprofitable.

The important thing to remember is that you take all of these points into consideration when backtesting a forex trading system because you need to be absolutely sure that a particular system is profitable before you start risking your own money.

Source by James Woolley

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