"Backtest makes perfect" -- this is probably the first time you've ever read that, and the accuracy of that statement can't be disproved.
Backtesting forex strategies is the same as practicing in preparation for the real thing.
Achieving consistency in profitability requires a firm grasp of what your trading system can do, and backtesting can help you with that.
In this post, you'll learn what backtesting actually is and its purpose. You will also get familiar with three applications that you can use to backtest your strategies right away.
What is backtesting?
Backtesting is the process of testing the viability of a technical trading strategy based on historical data.
This isn't the same as strategy testing with a demo account since demo accounts make use of real-time prices, which is more aptly termed as "forward testing."
But demo accounts can be used for backtesting as well, and that's discussed later.
What you'll need for backtesting:
- A charting package or trading application or a backtesting software.
- A trading journal or a spreadsheet.
- A trading strategy that you'd like to test.
What is the purpose of backtesting?
The objective of backtesting is to understand the performance of a technical trading strategy (e.g., success rate, drawdown, etc.).
It also gives you an idea about what you need to do with it.
In other words, are you going to make modifications or scrap it altogether?
Another thing you get out of backtesting is experience and confidence in your trading strategy.
This is because you know what to expect in your strategy or system since you've studied its statistics.
Is Backtesting only for Technical Strategies?
Now, the concept of technical analysis is based on utilizing past market information to predict the direction of prices; that's why it coincides with backtesting.
Moreover, technical analysis involves mathematical calculations of historical prices and trading indicators are developed off of that.
These technical indicators, which can be components of a strategy, require backtesting to get an idea of how it fared in past price data.
Three ways to manually backtest forex strategies
For this part, you'll learn about three applications that you can use for backtesting:
Backtest with MetaTrader 4
MetaTrader is a popular platform for forex traders for trading either a demo or live account, but it can also be used to backtest your strategy.
If you have MetaTrader4 on your desktop, here are the steps you can follow to start backtesting with it:
- Click FILE on the top left corner.
- Then, click OPEN OFFLINE CHART.
- After that, select a currency pair for testing.
- Next, click on the chart screen of the currency pair and then drag right (or, press ENTER on your keyboard and type the time format like this DD.MM.YYYY then press ENTER again).
- You can now begin adding the technical studies of your strategy on the chart.
- Identify your entry, risk, and potential take profit level and record them in your journal.
- And finally, press the right arrow button on your keyboard to advance the chart one candle at a time. Don't forget to record the results afterward.
Backtest with TradingView
Another free tool to backtest your strategy is through TradingView, and it works pretty much the same way as the MetaTrader.
It's a web-based platform that offers a little more tools than the MT4.
Once you have the platform on a new tab, click on the BAR REPLAY button located at the top side toolbox.
Then, a vertical line will appear attached to your cursor.
Drag that vertical line all the way to the date that you would like to do your testing on.
Once, you're ready, hit the play button and adjust the speed accordingly.
Take a look at TradingView's charts
Backtest with a backtesting software
The last method for backtesting your strategy is with a backtesting software like Forex Tester, which resembles the MT4 platform but is dedicated strictly for backtesting.
Forex Tester 4
An application that is strictly for testing strategies.
Improve your trading today!
Among the three methods for backtesting, the best one is Forex Tester simply because of its features and tools that are specially engineered to provide optimum backtesting experience for traders.
The capability of exporting backtesting results in a spreadsheet eliminates the need for journalizing your trades. And, it saves time for you in calculating everything from position size to profits and losses.
However, if you prefer a costless option, then TradingView is the way to go; it's easy to access and offers more tools, features, and markets to trade.