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Backtesting is very often mistakenly neglected by Forex traders, and despite many trading coaches, experts and books strongly recommending for every trader to do it, still, most Forex traders rarely backtest their strategies.
In most cases, they choose to go with what they are told by the seller of the strategy or they will first demo trade it for a while and then move on to a live account.
While demo trading is definitely beneficial and a must do before trading live, there are certain aspects where backtesting superior over demo trading.
It’s true, backtesting is not an easy or quick to do an activity, and it can require a lot of time and effort to be completed, but the effects and results that the trader will get from it are well worth it.
In this article, we will look at the main reasons for why backtesting is so valuable and important for any Forex trader to go through.
At face value, backtesting may look just like a way to get the numbers and probabilities for how well a trading strategy, system or pattern works. Like for example, whether it is profitable 50%, 60%, 75% or maybe 35% of the time. And while yes, you definitely will get the true win/loss ratio of a trading strategy by backtesting it thoroughly, those numbers are far from being the only thing that one gains from backtesting a strategy.
In the end, the other benefits of backtesting will probably turn out to be far more important than the simple numbers of winning and losing percentages.
Shortens your learning curve
One thing that surely comes first to mind about backtesting is that it literally speeds up the learning process.
You see, it’s not just the performance results of the strategy that you get (which by the way, may shock you positively or negatively), but also the experience and practice that you will get out of the backtesting activity.
One thing that surely comes first to mind about backtesting is that it literally speeds up the learning process. You see, it’s not just the performance results of the strategy that you get (which by the way, may shock you positively or negatively), but also the experience and practice that you will get out of the backtesting activity.
This process, if done by viewing the charts to see the different variations of the patterns and price action that form, will literally train your eyes to spot these same patterns in the future.
For example, you can backtest a classical pattern like the head and shoulders and literally see for yourself how well it works, how often it fails and what happened in each of these cases. While a trading guru or someone else may tell you that the head and shoulders pattern works 80, 60 or 50 percent of the time, it’s very different when you see that yourself.
This is simply because every pattern is unique even if it’s of the exact same type and there is so much more information to get from seeing the pattern in action as opposed to just knowing a statistical fact about it. The trained and master trader who’ve seen thousands of chart patterns and studied thousands of hours of price action can most often spot not only the pattern but also he can very accurately assess whether the pattern will work or fail in any particular case.
Shows the true performance of a trading strategy
Further, an in-depth backtest of a technical trading strategy will show how the performance of that trading strategy can drastically change as the market conditions change.
Market conditions are simply put the typical behaviors of the price action during different periods of time.
Most often those include trending, sideways, low volatility, high volatility etc. Conditions change constantly and with them, the performance of technical systems does too. This a crucial aspect that every Forex trader must be aware of – especially those who are heavily relying on technicals.
You may have a great trading strategy today that delivers 60% winning trades but it does not mean at all that it will not deliver 70% losing trades when the market conditions change. Most technical strategies suffer from this flaw and an in-depth backtesting can exactly show how the strategy performed during the different periods. In turn, the trader can later use these findings from the research and trade the appropriate strategies at the appropriate time and market conditions.
In addition, another very common problem of trading strategies is that very often a great looking strategy on paper proves to be poor when backtested. The trader who backtests avoids wasting time on demo trading a poor strategy or even worse – wasting money if he trades it on a real account.
Fundamental trading strategies are harder to be backtested, though it’s not impossible. Nevertheless, the backtesting exercise is still tremendously insightful and valuable.
Conclusion
Finally, a few words on trading statistics and probabilities.
Purely statistical facts from the past are important. In fact, from a purely technical point of view, the probabilities of how well a strategy or pattern performed in the past are everything.
All future trades are taken based on those statistics that are derived from past price action. Even professional traders look at those probabilities and trade by them so definitely it’s an important aspect to be aware of as a trader.
