How to backtest a trading strategy

How to backtest a trading strategy

When you found an interesting trading strategy (or designed it yourself), you need to check whether it worked in the past before you actually bet your money on it. This process of checking a strategy on the historical data is called “backtesting”.

When you backtest your strategy, make sure that you observe its performance for enough time and during different market conditions (trends, ranges).

There are 2 types of backtesting: manual and automated. The automatic backtesting is done with the help of programs, for example, Expert Advisors (EA) that open and manage the trades for you when certain technical conditions are met. To create an EA, you will need to know MQL4 programming language and syntax. As a result, in many cases, a simpler and more reliable manual testing can turn out to be a better solution.

Follow simple steps.

Step 1. Open the chart of a currency pair on which you want to backtest your strategy. It’s best to analyze one pair at a time. If necessary, you can do the backtest on another pair later. Apply the necessary indicators and tools to the chart. Scroll the chart to the previous period.

Step 2. Check the chart candlestick by candlestick looking for setups in line with the strategy you are testing.

Step 3. After finding a trade setup based on your trading strategy, write down the details of the potential past trade. You should write the date, entry point, stop loss, take profit and any other information you find necessary.

Step 4. Repeat the process until you find another possible trade setup and then go back to step 3.

When you have the results of potential trades written (we recommend using Excel), it will be easy to calculate the win-rate of the trading strategy.

If you find that your strategy performs poorly in backtesting, consider changing one variable at a time based on your observations, until you arrive at a profitable strategy.

Manual backtesting of a trading strategy requires time and discipline. However, if done right it will give you a good idea of the strategy’s success rate. Remember that you are backtesting a strategy for your own benefit. In addition, manual backtesting will give you a better understanding of the market and allow you to practice determining entry and exit levels.

It’s important to understand that the market tends to change. So, a strategy that was considered successful by the results of backtesting will not necessarily continue to show the same success rate in the future. This is why every strategy should be accompanied by sensible risk management.  

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