How to test a Forex strategy

04-03-2021

Every trader who wishes to make consistent profits in financial markets needs to have a solid forex strategy. In today’s article, we are going to discuss how to check whether it’s profitable and learn what parameters to use in order to test it.

Contents:

1. Forex Strategy: Testing Techniques
2. How to Test Forex Strategies the Right Way
3. How to Test Strategies: Tools
4. Let’s Sum Things Up

Forex Strategy: Testing Techniques

Suppose, you have already created your very own strategy or used an off-the-shelf one you’ve downloaded or borrowed from someone else. Now how do you figure out whether it can produce profits or not? You can obviously start trading it right away while learning everything you need to know about its profitability as you go. However, it is very risky and may leave your trading account empty as there is a chance to lose money if the strategy turns out to be insufficient or ineffective.

Another more realistic and safe way to do it is to test the forex strategy using the demo account in real-time mode. In case of a failure, it won’t lead to financial losses. With that said, there is a significant downside to this method — it is time-consuming. In order to make relevant conclusions, you need a large selection of trades that should include at least several hundred.

The third option is to track down how the strategy performs using history. To do so, scroll back the chart and start analyzing signals on historical data. The main difficulty lies in the inconvenience of this technique. Plus, the signal typically looks different from the way it was at the time when the decision was made.

And last but not least, there is a fourth way to test the strategy, and it is by using a forex strategy tester. This is probably the handiest testing method of all.

Key advantages:

  • It doesn’t take much time: you can adjust the testing speed.
  • It is done based on historical data.
  • The testing is performed in real-time imitation mode.
  • You can “make” a lot of trades and obtain results using a big data selection.
  • It is safe: you don’t risk losing real money.

How to test the strategy

How to Test Forex Strategies the Right Way

So, we have established that using the strategy tester is the easiest way to check the efficacy of your trading strategy. But before we actually proceed to exploring the technical side of this process, let’s see what you need to have prior to testing.

1. Forex strategy must be clear to you. The simpler it is, the better.

2. You need to have a complete understanding of the trading signal and how it looks (level breakout, bounce, divergence, the intersection of indicator’s trend lines, etc.).

3. You must know the allowed risk/reward ratio for a particular strategy.

4. Position entry rules must be clearly outlined. This can be done by creating a checklist you can refer to when needed.

For example, we open a long position when:

  • The price traveled no more than 20 % of ATR.
  • The price broke out the level from the bottom uliwards and confirmed it as support.
  • The risk/reward ratio must be 1:3.

How to Test Strategies: Tools

Once you have figured out the details of the strategy and understood when and how to enter the market, you can proceed to testing the forex strategy.

To test the strategy, you can use a built-in tester (available in MetaTrader 4 and MetaTrader 5) or individual software. For instance, Simple Forex Tester will be suitable for MetaTrader 4. You can find it online and install in the terminal. The testing process looks similar in both cases and includes following steps:

1. Choose a trading instrument and upload quotes from the archive.

2. Customize the settings of the testing: time range, time frame, spread size, intended Expert Advisor, tick model (the most effective one), and visualization.

3. Aside from that, you need to add all the relevant analysis tools offered by your forex strategy to the chart (levels and indicators).

4. Press “Start” to begin testing. You can also adjust the speed at which the chart will be drawn.

5. You can mark entry signals and trade outcomes directly on the chart or by making relevant notes in your trading log manually. With the Simple Forex Tester, you can even make virtual trades. In that case, you will receive testing results automatically.

Let’s Sum Things Up

To ensure that testing of the forex strategy goes successfully, you need to have:

  • Strategy checklist.
  • Appropriate testing method.
  • Reliable brokerage company. Untimely order execution, slippages, and other technical shortcomings may negatively affect your trading performance.

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