Importance of Backtesting in Forex

11 min read

As the Forex Market has merged with technology and evolved further, there have been numerous introductions of different strategies and models that work alongside different trading styles. The huge amount of trading variations has raised the question of how to predict and analyze if the chosen strategy is going to perform well. There are different ways to assess a trading strategy, starting from Scenario Analysis, Forward Performance Testing and one of the most popular out of all of them, Backtesting.

What is backtesting?

Backtesting is based on the hypothesis of if the particular strategy has worked in the past, then it has a high probability of performing well in the future as well. Method’s primary goal is to use historical trading data to analyze and assess the viability of the chosen strategy or pricing model by using. The main idea behind using the data retrospectively is to take a specific chunk of it for testing purposes and if it turns out to be successful then later use it with the high potential of its feasibility. The process can be assimilated into the simulation, experimenting with different strategies to see how they perform and they later use the one that worked the best. 

The case of more complex trading strategies such as automated trading systems needs extensive backtesting to prove how profitable they can be. Usually, the companies backtest their EAs before releasing them for retail. Due to the fact that automated trading seems to be more new to the market, backtesting is one of the best ways to prove the legitimacy of the Expert Advisors. 

The ideal scenario behind Forex backtesting should be a chosen sample data from a certain period of time that denotes different market conditions and irregularities. One of the keynotes that a lot of traders seem to be missing is that backtesting software should also take into account the trading costs. On one occasion it might seem to be too insignificant but as time goes it adds up might result in a different picture.

Backtesting does seem to be a good method to analyze a strategy on its own, but it shines more when used with other techniques. Out-of-sample testing provides additional reassurance that the strategy is going to be effective in the future.

Best Forex Backtesting Software

MetaTrader 4/5

MetaQuotes developed one of the most popular Forex trading software, MetaTrader 5, which stands out from its predecessors by being developed on an entirely new coding language MLQ5 which introduces numerous features that have not been seen previously before. 

MetaTrader 5 does have a backtesting feature that helps traders to optimize their strategy before going live. In addition to MT5 being one of the most popular trading platforms, it also has the ability to backtests fully-automated Forex trading robots (Expert Advisors). For the first-time traders that are just starting out in Forex, MetaTrader 5’s functionalities might seem a bit too complicated and hard to understand compared to others.

Another MetaQuotes creation in our list is MetaTrader 4 which also offers a backtesting feature. MT 4 Offers a very simple way of running a backtest on the platform with the help of Strategy Tester. The key to success when doing a backtest is to have complete and accurate historical data, if not then the result is not going to be accurate. 

How to run a Backtesting on the MetaTrader platform 

First and foremost, go to the view and click Strategy Tester or simply use the shortcut Ctrl+R. After that, the Strategy Tester Windows is going to appear with different options and drop-down panels.

The next step is to select the Expert Advisor or a trading strategy as a testable element. There are many developed EAs on the market or you can create one yourself as well. After choosing the Expert, then you should select the trading symbol which indicates a Forex pair. The next step is to select the relevant time frame for the backtesting and after that the model of backtesting. With seven different timeframes and three types of models, there is plenty of room for experimenting (Although the platform suggests using the “every tick” model).

The results of the backtesting can be found in the tab with the same name and it displays different statistics such as total net payout, loss, the number of positions with positive and negative outcomes, and many more. 

Forex Tester

Being one of the most frequently used by FX traders, Forex Tester is one of the leading backtesting tools that’s out in the market. The software allows the traders to access any point in the historical data, in addition to the integration of fast-forward analysis.

Excel

If you are interested in doing backtesting manually, Excel is the way to go. This popular Microsoft software that has been used in various fields has found its way to the Forex industry. The whole process is more tricky than using specially developed forex backtesting software. For this method, you would need to backtest on another platform (preferably MetaTrader 5) but then transfer the backtest results into the spreadsheet to better visualize the patterns and afterwards make trading decisions. This process might seem a bit outdated but the overall quality of the result is unbeatable. 

TradeIdeas

If we take into account that artificial intelligence becomes more and more relevant in financial markets, this particular software utilizes the full potential of AIs to help traders earn more returns. TradeIdeas offers one of the best event-based Forex backtesting in the market right now.

Soft 4 FX

Another industry favorite, Soft 4 FC offers traders a manual Forex backtesting solution. This tool acts as a plugin in MetaTrader and allows you to select historical data to then use it to enter trades in the market with the function of tracking the statistics.

Risks of Forex Backtesting and How to Avoid Them

Just like any other methodology, Backtesting also has its downsides. One hardest part of the Backtesting process is to develop a strategy without using historical data yourself. If you solely rely on previous results the backtest results are going to be unrealistically good which would mean nothing in the end. Traders should also avoid using the same data over and over because the test might show positive results but in the real-time market, it might have a totally different outcome. 

With backtesting, there is also a chance of possible overfitting, which means that there might be a successful strategy that has worked previously but might not yield the same results. This is why it’s crucial to keep in mind that previous performance is not an indication of future results.

We have stressed the importance of historic data, but most of the time traders prefer to do backtesting on Forex demo accounts which might not have 100% accurate data compared to real accounts which might lead to having inaccurate results. On top of that, you have to keep in mind that the Forex industry changes constantly and with that the Market patterns vary from time to time. If the volatility changes for the whole market the actual result might differ from what the backtesting showered previously.

Backtested Expert Advisors

As mentioned previously there are numerous ways to do backtesting manually, but on the other side of the spectrum, there are different automated trading robots that have already been backtested and are successfully operating for a good amount of time. Sometimes choosing the already backtested option might work for some, due to the intensity of the Forex backtesting process that might not be the best solution for novice traders. 

Athena EA

Key Stats: Values:
Historical Yearly Performance 200%
Historical Drawdown (DD) 30%
Risk Reward Ratio (R: R) 0.36
Profit Share (€0 upfront fees, 20-35% profit share)
Software Rental €499 per year
Live Performance on 

One of the most powerful automated trading robots with an aggressive trading style that yields a 200% yearly return. You can run backtesting with Athena EA on MetaTrader 4.

Zeus EA

Key Stats: Values:
Historical Yearly Performance 100%
Historical Drawdown (DD) 43%
Risk Reward Ratio (R: R) 0,65
Profit Share ✅ (€0 upfront fees, 20 to 30% profit share)
Software Rental Rental €699, Lifetime €999  
Live Performance on 

 

Elite CureenSea has introduced Zeus EA as one of the fastest Expert Advisors that has the ability to analyze multiple markets at the same time. Zeus EA’s trading style differs from Athena EA’s, it chooses to make a lower-risk decision with lower drawdowns. 

FAQ

How can I backtest FX for free?

Most people have access to Microsoft’s Excel or Google Spreadsheets where traders are able to manually backtest any given strategy and see the result. This does require more time but is not as complicated as you might think. TradingView is also another free FX backtesting platform that requires less time than Excel and the test can be done on your browser.

Is it important to backtest in Forex?

Backtesting is one of the crucial factors in creating a trading strategy. It helps traders optimize and improve their strategies by analyzing historical data. With backtesting, traders can potentially avoid any technical or theoretical mistakes which gives them more confidence in their strategy.

Leave a Reply

avatar

This site uses Akismet to reduce spam. Learn how your comment data is processed.

  Subscribe  
Notify of