3 Goals Of Forex Back Testing
Your back-testing will allow you to do two things: First, you will identify how suitable the trading system is for you. This does not mean you are discovering whether the trading system is profitable, but, rather, you are examining the fit between you, the trader, and the rules of your trading system. Second, you will learn to trust your trading system and learn to let go of your trades. You may trade in a more relaxed manner once you have taken thousands of trades over years of market data. The confidence gained by trading your system repeatedly will show up in the form of a
relaxed approach to your live trading. Third, you will gain expertise with your trading system. This may only happen if you take many trades, and back-testing is a quick way to accumulate many trades. A close look at each of these three goals may help you to get the most out of your back-testing.
Is the System Suitable?
How suitable is your trading system? The first goal of back-testing is to find out how suitable the trading system is for you. I have a good friend, who introduced me to forex, named Ashkan Bolour. Bolour is a well-known forex trader, you may have read about him in the Millionaire Traders book by Kathy Lien and Boris Schlossberg. Bolour trades the three-minute and 5 minute charts. He does exceptionally well trading these charts. No matter how many times I watch him trade his systems on these charts, I always fail when I try to trade as he does. I fail because his trading system does not fit with my view of the markets. I prefer the daily, weekly, and four-hour charts. I have great difficulty watching my trades fluctuate, which is precisely what Bolour does when he trades. I have learned to trade systems that make sense to me. I am better at extracting profits from the longer term charts. Your job is to find out how you should be trading, and trade only what makes sense to you.
Perhaps you have traded several trading systems in the past. Most of these systems probably looked outstanding at first glance. Maybe you paid for the trading system, and the website you bought it from painted the system as an invincible profit-collecting machine. Or maybe you read about the system on an Internet forum. Or perhaps a friend told you about the trading system. No matter how good the trading system appears, it is remarkable how your trading results often differ from your expectations of the system. How can a perfect, profitable system fall apart in your hands?
Why is it that a system that sounds good does not work once you start trading it? The answer is fit; if a system does not fit your view of the markets, your approach to trading, your ability to execute trades, it will not make money for you. A system must fit with your understanding of the markets. If you believe the five-minute chart is “random noise,” you may be better suited to
trade the daily chart. If you believe moving averages are useless indicators, you will not be comfortable with a moving-average-based system. If you think that the USD/JPY is a terrible pair to trade, you are not going to trade a system on the USD/JPY. Your beliefs about trading must fit your trading system.
Your lifestyle will also determine the types of systems you may trade. If you have a full-time job, and spend 10 hours of the day at an office where you will not have access to your trading platform, you probably will be drawn toward longer-term charts. Daily, weekly, or four-hour charts may be best for you. This way, you may take your trades and manage them by checking the charts once or twice each day.
Your makeup as a trader will also determine how you should trade. Perhaps you freak out when you are in a trade on the lower-timeframe charts, such as the five-minute charts. Perhaps it is torture watching the profit and loss fluctuate greatly with each pip gained or lost on these lower timeframe charts. If this is the case, you will probably want to trade higher timeframe
charts. If you are risking the same percentage of your account on each trade, it is likely that a trade on a lower timeframe chart will risk more per pip because the stop loss is closer to the entry price than a trade on a higher-timeframe chart. Your back-testing experience with the trading system will show you whether you will be able to find profits with a system.
Testing will also show you whether your lifestyle will fit with the system. Perhaps most of the trade signals for a trading system occur during the European market, and you are fast asleep during that time; this may mean that the trading system is not for you.
Confidence Is Letting Go
After you have found a system that fits your personality, your view of the markets, you need to get comfortable trading this system. This will be the second step you take on your way to consistent profits in forex. The key here is to gain experience over a broad range of market conditions. Relaxing while you are in a trade will often help you manage the trade better. Just the simple fact that you are relaxed means your decision-making will be better.
Relaxation will come for you once you have confidence in your system, a confidence gained by trading your system repeatedly, over years of market conditions and a variety of signals. You will learn to trust your trading system and learn to let go of your trades. Micromanaging trades, particularly trades on higher timeframes, is a common mistake of novice traders. If you can walk away from your computer after making a trade, you have confidence in your system. This confidence is only available to traders who have back-tested extensively.
Accelerate your learning curve by back-testing. It does not matter your method of back-testing; it only matters that you do it. Testing over thousands of trades will enable you to be better prepared to make a decision on your trading system. Once you deem your system profitable, you can begin to get comfortable with the system by testing extensively, slowly building your database of trading experience with the system. Your next step will be to become an expert with your system.