Backtesting Forex Trading System

Abstract:
Generally, the phase of backtesting comes after development or selection of a trading system. Likewise, after selecting or developing a particular Forex trading system a trader can go back, i.e, using the historical data, and start testing it, that’s why it is named as “backtesting”. It is necessary, for through backtesting the Forex traders can test the efficiency of their system.
Backtesting of a Forex Trading System is usually done after developing or selecting a particular Forex trading system. A trader may select any kind of Forex trading system based on personal interests or can develop his or her own trading system. Therefore, it is necessary to test the efficiency and profitability of the system before using it.

Thus, Backtesting refers to the practice of examining the efficiency of a trading system which will perform under disparate market conditions. A positive result makes the trader confident about the fact that the system will not under perform when needed. Without backtesting the trader will not be able to gain the confidence.

However, backtesting a Forex trading system basically involves in examining the performance of that system against some historical market data. Therefore, the hidden bugs, which may cause some flaws in future, in the system get uncovered which ables the traders to adjust themselves accordingly or make necessary corrections.
As a result, risk factors can be reduced to a large extent.

Generally the time needed for backtesting depends upon the complexity of that system. While backtesting a Forex trading system, several things need to be kept in mind. These are, volatility, annual returns, average gain or loss, total amount of profit or loss during the specified testing period, risk-adjusted returns, historical data range, amount of capital that is exposed to risk etc.

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Last Updated on : 23rd July 2013