Before reading through this lesson, you should have read through:
Backtesting 30 trades manually with acan help you decide whether a is worth pursuing. However, if you are looking to trade a new strategy over a much longer term, then you do not want to have to wait for months before you can make a decision on whether to use the strategy on a real money .
Different ways of backtesting a trading strategy automatically
This is where backtesting a strategy using software helps. You can get an idea if the principles of the strategy hold up over a longer term much more quickly. You can do this in two ways: using backtesting software or using a robot.
Using backtesting software
You can use special backtesting software, such as FOREX TESTER, that allows you to test a strategy over a longer period of time, using real historical data. This type of software allows you to rewind the historical market data and trade through a number of days, weeks or months by speeding up the time.
Using a robot
An alternative to using backtesting software is to use a robot or an Expert Advisor. The robot would go through the historical data at a fast pace and mimic the trades that you could have taken using the strategy, allowing you to see what your results would have been like.
Considerations to bear in mind
Whether you use backtesting software, such as FOREX TESTER, or you use a robot to test historical data, you must bear in mind that past performance is not indicative of future results.
When you are testing a strategy, you should not be trying to see how much percentage increase you can make on your account or how much money you could make. The simple fact is that you will never know what thewill do and so from one month to the next you will not know what kind of performance you can achieve.
When you are backtesting a strategy, you are seeing if the principles of the strategy will work with certainor in certain market conditions.
If, for example, you are looking to test a strategy that captures part of aand successfully filters out trades in a , then by testing the strategy using software, it will allow you to see if the strategy actually manages to achieve this.
If the results turn out to be unprofitable, then you may want to consider ways to filter out unprofitable trades and reduce losses. If the results turn out to be profitable, then you may have a strategy that you can work with in a live market environment.
Avoid curve fitting
However you must bear in mind that you should never tweak your strategy to the point where you achieve maximum profitability. This is known as curve fitting and means that you have optimised your strategy to achieve the maximum performance possible based on what has happened in the past.
Past performance is not indicative of future results
This will not help you in the future, because the conditions in the past that gave you a substantial performance on your over-optimised strategy will change, even if slightly, and you will not achieve the same results.
You need to stick to making sure that the principles of the strategy work and look to optimise your strategy in a live environment based on current market conditions, not past market conditions.
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Backtesting is not exact
You should also be aware that there are other practical factors that can affect you results. First of all, differenthave different price feeds and . Using different brokers to test a strategy may produce different results.
Practical application will be different to backtesting results
There is also a difference between practicing a trading strategy and applying it in a real environment. In a live environment you are more likely to succumb tol influences. You are also likely to make mistakes or react more slowly when you are actually trading a strategy. You should be cautious as you will most likely not be able to execute trades as consistently as a robot does, or as well as you do in a practice environment.
Large position sizes can can change results
When you have a small starting capital, you are limited in the amount ofthat you can trade. As your account size grows, you can trade with more volume and increase your risk to get larger returns.
However, when your account becomes very large, this can produce a unique set of problems. For a start, in certain markets where theis very thin, you can actually move the price of the asset simply by placing your .
This may give you slower execution speeds or you may not be able to get the exact price that you want. Using backtesting software over historical data will not take these factors into account, whereas in a live environment, they will be inherently present.
Backtesting is a means of deciding whether a strategy is worth pursuing or not
On the whole, backtesting using software can be very useful. Although it cannot generate a concrete conclusion as to how much you can increase your account by, or how much you can make in the future, it can give you a good basis as to whether your strategy will work or not.
By testing your strategy out over a longer period of time, you get a larger sample size and this makes the testing environment more accurate, leaving you to feel confident that the underlying principles that you built a strategy on, hold up over a longer period of time.
So far you have learned that...
- ... if you are looking to trade over a longer term, you can make use of software so that you do not have to wait for months before you can decide if a strategy is worth pursuing.
- ... there are two different types of software that you can use: backtesting software and automated robots.
- ... backtesting software allows you to use historical market data by rewinding it back and trade as if you are trading live. You can speed up the price action and trade through weeks of data in a short space of time.
- ... a trading robot, such as an expert advisor can automatically trade through historical data allowing you to see what your results would have been like.
- ... when using automated backtesting software, there are a number of considerations that you have to bear in mind.
- ... the idea is not to see how much you could potentially grow your account by, or how much you can make per month as you will never be able to know what will happens in the markets. Rather you should use the results to see if the principles of the strategy hold for different asset or market conditions.
- ... you should avoid curve fitting – optimising your strategy to achieve maximum performance based on past results.
- ... there are external factors that can influence your backtesting results, such as price feeds from a broker or the difference in spreads between brokers.
- ... applying a strategy to the markets is very different to backtesting a strategy. You are more likely to come under emotional influences or make mistakes when trading in a real environment.
- ... when your account becomes too large, you can actually move the price of the asset, just by placing your order. This may result in slower execution and undesirable prices that would not be factored into your backtesting.
- ... backtesting should not be used to find concrete evidence of returns, but rather used to decide whether a strategy is worth pursing in a live environment.
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