Should you back test your strategy?
In this weekly video:
00:22 – Should I and how do I back test?
01:00 – Why back testing is beneficial
02:02 – Live testing can be very slow
03:08 – How do you back test a strategy?
04:02 – Other benefits of back testing
04:40 – Good back testing is very beneficial
Is it beneficial to back test your forex strategy? Let's talk about that and more right now.
Hi traders. Andrew Mitchem here, the Forex Trading Coach of video and podcast number 284.
Should I and how do I back test?
Now I get a lot of questions about back testing and people will say, “Hey Andrew, should I back test? How do I do it? What's the best way of doing it? Is it a waste of time?” All those kind of things. And I suppose it depends on who you talk to, depending on what answer you get. But my opinion is that back testing is very, very important and I strongly encourage clients to do that.
A number of reasons why. But it's also important to understand that you have to do good, thorough back testing. You know, not just be a bit blasé about it. It had to be very thorough in order to get the best amount of information from that.
Why back testing is beneficial
And what I love about it, as someone who does a lot of manual trading, is that it encourages you to look for patterns, and it also trains your eye for looking for patterns, without that real life pressure of trading right now.
The downside with forward testing as in like learning something, whether it even be on a demo, but learning it live is, it's very emotional, very psychological, sort of, not so much damaging, but you know, it can affect your trade decision by having something happening right now live in the market, but also it's very, very slow. And it's also highly dependent on what the conditions are right now.
So I'm filming this. We are August, traditionally a very, very slow month. July was typically slow, like July is most years. Northern hemisphere, summer holidays, vacations, etc. And probably expecting much the same to happen in August.
Live testing can be very slow
So live testing now for the next month may not give me that full appreciation and that full understanding of what my strategy, if I'm learning a new strategy, could be like.
However, back testing can give you some really good information. But like a lot of things, practice is okay, but bad practice is not good. Good practice is good, if you get what I mean there. Because you know you can just keep doing the same old thing, same old thing, but if you're making mistakes with that, that's not great. But really good thorough practice I believe is very, very good.
Because it helps you to gain confidence within your strategy. And if you can see a strategy or a pattern, whatever it is that you're looking for, work historically well throughout month by month, year by year. That has to give you that confidence that you need to trade that strategy live in real time, when it's very, very slow. Because you know, you're going to wait day after day.
How do you back test a strategy?
So how do you go about doing this and what can you get from it? Well, there's a number of ways you can go about doing it. But the best thing is to either buy some back testing software, or download good historical data from your broker and go through it very thoroughly looking for the patterns that you're looking for, looking at the price levels.
But be careful if your strategy uses too many indicators because a lot of indicators look different when you're looking at them in hindsight in historical information than they do live, because most indicators are moving throughout the formation of a candle. However, that doesn't affect me and my strategy because I only ever look for a trade setup upon the completion of a candle. So you need to just be aware that if you're using indicators and taking trades that are not candle based related. So that's one thing there.
Other benefits of back testing
But what it can also do is have enormous benefit when you're looking at back testing. Because you might find that your strategy may not work very well on a Monday or a Friday, or it may not work very well for the first five hours of the day and as soon as the European session starts to kick in, then it works tremendously well. So it's different things like that that you can make from your analysis when you use back testing data correctly.
And as I mentioned, trading, when you go live, not only is it slow, it is psychologically, you know, different than simply looking through historical data.
Good back testing is very beneficial
So I believe yes, the answer is yes. Good back testing is very, very good because it helps you gain confidence in your strategy. It helps train your eye of what you're looking for, if you are looking for patterns and it will tremendously help give you confidence when you are through quieter times like we've just seen in July and likely to see into August. It helps give you confidence because you can do a number of things.
You can either say, well, I'm not trading in August, well let's say. Or you can say that traditionally August has always been a little bit slow on the daily charts. Therefore I'm taking my strategy down to four hour charts, one hour charts, until the market conditions improve and increase in volume. So various things like that you can do.
So if you do it right, it's say a massive advantage to you. So I hope that helps. This is Andrew Mitchem, the Forex Trading Coach. I'll see you this time next week with more trading tips and information.