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Whenever you are planning to do something, it is always better to first test it out risk-free, or at the very least manage your risk-reward ratio. This is true for almost everything in life and Forex trading is no exception.
Backtesting in Forex is a process of testing out a certain strategy (or an indicator) in different types of market conditions. This is usually done by special backtesting programs, that are capable of applying the strategy to different market conditions, to help you determine how useful it could be.
This way, you will be able to decide if it is worth using a certain trading strategy or if it will result in too many losses. In today’s guide to how to do backtesting in Forex, we are going to discuss different ways of backtesting and how you can use it for the best outcome.
Learning how to do backtesting in Forex is a very important step toward developing and identifying useful strategies for trading. The definition of backtesting is very simple and can be defined as a method used by Forex traders to determine how useful a certain trading strategy would be in different market conditions.
Traders are using the historical data of the market to test out the strategies that they have come up with to see how they would react to different types of developments in the market. It is based on the theory that if a strategy was successful at one point, it will continue to be successful under similar market conditions.
By using a Forex strategy tester, traders can analyze the risks as well as possible profits before making any actual moves in the market. When backtesting, if your strategy gives you positive results, you can be assured that it can be implemented in reality. On the other hand, if the results are negative, you can adjust or change the strategy to maximize its profitability.
It is common in the Forex trading market to backtest different types of strategies, but it is most pivotal for complicated strategies, as it is almost impossible to determine their effectiveness otherwise.
Backtesting works in many different ways, and it is common for individual traders to work with qualified programmers to develop a testable form of their trading ideas.
Backtesting in Forex is a very broad and general topic that incorporates different methods used to check the effectiveness of their trading strategy. For example, there are some people who prefer to manually test their strategy, while others use automated Forex backtesting software.
Backtesting a strategy manually can be quite overwhelming and time-consuming. Because of this, it is only natural that the majority of traders in the market are using automated backtesting programs to check the effectiveness of their strategies.
Below, we are going to discuss automated and manual ways of backtesting trading strategies.
There are different types of Forex trading testers available in the market. These pieces of software are generally created by experienced traders and are aimed at making backtesting a much easier experience.
Getting yourself some free backtesting software should not be that hard as there are many available in the market. These programs are able to provide traders with different types of information about the market. One of which is the return on equity, also known as ROE.
These are returns that are expressed in terms of the percentage of total equity invested and can help traders understand how useful a strategy can be. Some programs also provide traders with information about total profit and loss, which is the total number of losses and profits generated by the strategy.
Traders can also receive information about volatility and how useful the strategy was in high or low-volatility markets. All of these metrics can provide traders with detailed information about the usefulness of the strategy that they have devised.
There are numerous free Forex backtesting software options available in the market for you to choose from. From regular Forex simulators to sophisticated testing platforms, you can always find something that fits your needs. We will discuss specific programs for backtesting below.
While getting free backtesting software to automate this process is a great idea, there are some traders in the market who prefer to take control on their own and truly grasp all the ups and downs of their trading strategy through manual research.
Testing out the effectiveness of a strategy manually requires a lot of time and dedication. However, it is perfectly possible. You can test strategies manually by taking the historical data of the market (from any source available to you) and observing the price fluctuations candle by candle (if using the candlestick chart).
This way, you can observe the price action in detail. While it can be quite hard to do, it does come with several advantages. One of the biggest advantages is that you will identify and try to resolve the problems of your strategy on your own.
This way, improving the strategy might actually be a bit easier. It will also give you the chance to better understand how the Forex trading market works in general.
However, backtesting a strategy manually also comes with several disadvantages that are not associated with backtesting software. This includes a lack of efficiency and higher chances of making errors.
One of the most used platforms for backtesting a Forex strategy is MetaTrader 4 (MT4). This trading platform comes with a built-in backtesting tool, which is very effective. To find it, you should go to the View section of MT4, where you will be able to find the Strategy Tester option.
You can also simply press CTRL+R on the keyboard, and choose the tester button from there. The MT4 tester is called Strategy Tester and is one of the most popular trading simulators available in the market today.
Combining this tool with the built-in charts and trading indicators of MT4 creates a perfect opportunity for testing out a certain strategy. You can also find strategies that have been created by other traders and test them out before putting them into practice.
Since MetaTrader 4 has been around for such a long time, it has a very large following. Thus, numerous strategies, some of which were created by professional traders, are available online. Because of this, many see it as the best free backtesting software out there.
A great thing about it is that it can be used with a demo account as well, which means that you do not have to sign up with a specific broker to use the MT4 Strategy Tester. There is another tool available for backtesting on MT4, which is called the Forex Tester.
However, this option is not free on MT4, but it can be used for automated, as well as manual testing activities. The Forex Tester comes with pre-determined and created strategies that traders can use. It comes with 16 years of market data, which is truly priceless and can be very helpful for determining how accurate a certain strategy is. Using the Forex Tester is very easy and simple.
Once you open the Forex Tester window on MT4, you will see numerous buttons as well as a drop-down menu for different elements of the tester. One of the ways used for backtesting is to choose the Expert Advisor as a testable element and test a specific EA program.
You can also choose indicators that you want to test very easily. Any EA can be tested here, even the ones that you have created. You can also choose any Forex pairs you want to trade. After this, you simply set the timeframe and the model of backtesting you want to employ.
There are usually about 7 different timeframes (depending on the broker, there can be more). As for the models, there are ones like Every tick, Control points, or Open prices. It is believed that the Every tick option is the most accurate one on MT4. Then, you choose the type of position; long, short, or even both, and let the platform do its work.
The Forex backtesting software's free version provides information in a simple manner. There is a special Results tab in the tester window, where you will be able to see the findings of the test.
Depending on the timeframe selected and the computing power of your device, it can take anywhere from a few minutes to hours for the process to complete. The final data includes information about the total net payout, as well as loss. You will also be informed about the number of positive and negative positions.
While MT4 is by far the most popular trading platform to backtest with, there are many others available in the market. Some people view MT4 as the best backtesting software for Forex, but this does not mean you should not use others.
Below, we will talk about some of the alternative ways for backtesting a Forex trading strategy. So, follow our guide to learn more about the best free Forex backtesting software and where to find them.
Demo trading is a very popular way of analyzing the effectiveness of a certain trading strategy on your own. Almost all Forex brokers offer such accounts these days, and they can be quite beneficial for traders.
It is a very common misconception that demo accounts are only for beginner traders. Demo accounts are often used by well-experienced traders as well, and are employed by them to test out new trading strategies, and tweak and adjust them to improve their effectiveness.
Paper trading is essentially the same as demo trading. However, it is usually done in a more manual way. For example, one could use Excel to track the price movements in the market and calculate everything on their own. Some traders even use simple pen and paper, which can make things a bit harder.
While this is a lot harder than using free backtesting software that can be found online easily, it is still employed by many traders today in order to have a better connection as well as an understanding of the trading markets and the way things work.
Using a demo account and paper trading is totally risk-free, as you do not test your system using actual funds.
Earlier in this guide, we discussed MT4 as one of the best options for testing, but there are many other Forex strategy tester programs online that you could use. One great example of this is the Profit Finder of the NinjaTrader platform. While not as popular as MT4, NinjaTrader is used by many traders in the market.
The Profit Finder can be used to identify the chances of making profits with a certain strategy or automated system. After providing all necessary information, such as the account size, ideal entry and exit points, take-profit levels, and timeframes, the system provides traders with very detailed information about the effectiveness of their strategy.
This includes gross and net profit ratios, as well as possible losses. It works on trading strategies, and instruments, as well as on technical indicators. It is used to read entries and exits automatically and performs numerous complex calculations in a very short space of time.
Another great free Forex strategy tester is TradingView. This is an online program that is known for offering traders different types of advanced charting tools. It is completely browser-based, which makes it super easy to use.
In addition, it is also a social platform, where traders can get in touch with others, exchange ideas about trading, and find out what other traders are doing in the market. A special tool for backtesting on TradingView is called the Bar Replay Feature, which lets traders adjust the settings according to their individual interests and needs. It offers traders amazing historical data on the market, which is pivotal for successful backtesting.
While backtesting is a great way of identifying the best strategies in the market, it does come with several disadvantages as well. Below, we will discuss the major advantages and disadvantages of backtesting.
There are two options for traders to backtest Forex. One is manual backtesting, another is by using backtesting software. When using software, things are a lot easier. You choose which trading strategy you want to use and a platform where you want to backtest it. After this, you code the strategy into a language that can be read by the platform.
Then, you add the strategy into the backtesting tool and choose the options according to your preferences, for example, which currency pairs to test, timeframes, which charts to use, and so on. After this, you wait for a certain amount of time, depending on the timeframe used and the capabilities of your device, and you receive detailed information about the outcome of the backtest.
Yes, using the best Forex backtesting software is very important for trading currencies. It gives traders very detailed information about the strategy they are using and helps them identify the problems that the strategy might have. It makes it easier for traders to plan their trading and have a better understanding of the possible profits or losses they can make.
To backtest a Forex strategy manually you will first have to download market historical data from accurate sources. After you have the historical data of the price fluctuations in the market, you can continue by testing your strategy on it.
Manually backtesting a Forex strategy requires a lot of time and dedication from traders. It can be done in several different ways. For example, you can use an Excel file to write down all the price movements in the market and analyze how your trading strategy would work under the same market conditions. Compared to backtesting using online programs, manually backtesting the Forex market can be more time-consuming and less accurate as there is a greater chance of making errors.
The purpose of backtesting in Forex is to identify how well a strategy or trading mode would perform under different market conditions. It is used by Forex traders to determine how useful their strategy is, what the problems associated with it might be, and how these problems can be addressed and resolved.
If the results of the backtest are positive, you can implement the strategy in the live market.
The time period of backtesting depends on the average holding period of your position. For example, let's say that you are using a strategy with a holding period of over one month, it means that it would be a better idea to use a long time period, like 15 years, for example. In general, the longer the period you backtest your strategy, the more opportunities you have for identifying all the flaws that your strategy might be associated with.