Backtesting has both fans and dissenters, but it remains a popular way to test the merits of an algorithmic strategy. A forex backtester might say, “if the system or algorithmic trade worked in the past, why wouldn’t it work today?”
Backtesting a forex trading system isn’t particularly hard. With the advent of online trading, and desktop based trading platforms, most traders should be able to backtest any simple strategy and get a concrete look at its effectiveness. Backtested strategies are typically scored on the following criteria:
Profit/Loss – How much did you make or lose.
Maximum Drawdown – What was the greatest dip from the peak on a chart. For example, an account that went from $150 to $125 would have a maximum drawdown of 16.6%. (16.6% is really good).
Win/Loss Ratio – What percentage of trades were winners or losers. This is important for strategies that use differing values for stop loss and take profit orders.
The most important number of the above mentioned is the maximum drawdown number. This number will tell you how risky you can get with the strategy, and how to squeeze more profits from the same account. With a maximum draw down of only 16.6% as exemplified above, a trader could realistically increase position sizes by 5 times over and have a maximum drawdown of 83%.
83% is a large paper loss to be holding, however, if the strategy is profitable then short term losses don’t really matter anyway. Besides, the strategy with a draw down of 83% with all things being equal would be more profitable than the strategy with only 16% drawdown.
The Hardest Part of Forex Backtesting
The number one issue traders run into when backtesting a forex strategy is how to do it. You could do it all by hand, spend hours with a calculator and a pen or you could code it, program it, and plug it into a trading platform. If you’re not familiar with backtesting or coding forex systems and automated trading programs, you mgiht be best doing it by hand, or paying someone (yes, companies do exist for this purpose) to code the system for you.
