How to Conduct a Trading Strategy Back Test

I almost tried to hide the title of this article or change it to something like “How to Make 637 Pips on a Slow Day” to trick traders into reading it. Why would I do that? Because this is a boring subject that most traders will run from, but oh how they need it. Conducting proper back testing can change your forex trading forever. Before you leave I will let you in on a secret I am going to have complete back test and I am going to share the strategy so this is going to have a ton of good stuff.

This article is going to discuss how to do a back test to determine if a strategy is profitable before you start to trade it. The key word is BEFORE you trade it. The problem with most traders I know is that they usually start trading with no, testing at all heck they don’t even have a plan or a strategy. I am not trying to be cruel here but I deal with traders every day and I am asking them these key questions to try to find out where they are going wrong.

So this post is much needed and I hope that you heed the words that have been written so that you may learn and be profitable.

There are some benefits to back testing a strategy before trading. The first benefit is that you will know ahead of time if a strategy actually works and if you are wasting your time or not even before you start trading live. Another great reason to back test is that you learn the strategy very well before you actually start to trade, believe me after a couple hours of straight back testing you will know you strategy inside and out. Back testing a trading strategy also allows you to test different variables with your strategy to see if changing something will increase your profits. The two small drawbacks to back testing are that the results cannot be guaranteed in the future so if you find a good one your results might not be what you actually expect when you start to trade. The other drawback is that to do it right it takes a lot of time and hard work but that can be a benefit as well.

Steps To Start Back Testing

The first thing you need even before you start back testing is a forex trading strategy. I have include a link to for your convenience to a Forex trading strategy website in case you need a strategy to test. Once you have your strategy you have to make sure that you understand all of the entry requirements, money management, exit requirements, and all of the indicators you will need for this strategy.

Once you fully understand the strategy you need to choose a pair that you are going to test on for my example I am going test on the Aud/Usd. You also have to determine how far back you are going to test. I recommend testing it a minimum of 2 months but you should probably do more.

For the example I am going to test I am going to test for one month.

Here is the my strategy for this example:

Indicators Used:

1 Hr Chart

7 and 27 Simple Moving Average

Macd 8 17 9

Rsi 14

Entry Requirements:

Enter on a Cross of the 7 and 27 Go in the direction of the cross.

Filters to keep us out of bad Trades.

Also RSI Must be above 50 pointing up for a long and below 50 pointing down for a short.

If RSI is  above 65 no trade on a long

If RSI is  below 35 no trade on a short

Macd above 0 for a long and below 0 for a short.

Wait for the candle to close before entry.

If the Entry candle is larger than +50 no trade

Stops Loss And Take Profit Information

Stop loss 3 pips above previous candle to the entry

Move Stop to +30 when the price gets to +50

Trail Stop by 27 MA candle after the price gets past +30

 

Money Management

Risk 2% of account on each trade

 

I know I am going into a lot of detail here I didnt have to include the strategy but I want to go above and beyond the call of duty and give you some great information that will change your trading forever.

Chart One the area between the green lines indicate exactly 30 days of time. From May 17 to June 17th.

 

 

 

 

Chart Two Next I am going to look at all the times I think the price is going to trigger a trade and mark them on the chart.

 

 

 

 

Now we are almost ready to start the back test but before we do that we need to create a spreadsheet that will have all of the data we record from the backtest.

Here is an example of the first trade I recorded.

Now I go through and do the same thing with each trade. After I have completed the entire back test and log the results I look at the numbers in the speadsheet and make my observations of the strategy.

Here is a graph of the performance.

So now that we see the strategy is a winner, now it is time to fine tune it to make it better. The strategy was profitable but if I made some small adjustments it could be much better. If I add one or two more winning trades to the mix or get some more pips per trade, that would be a large increase in profit over time.

 

So now back to the drawing board I am going to follow the same rules and make a few changes to see if I can improve the strategy. If you have any comments please share them below.

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Casey Stubbs is the founder of Winners Edge Trading, which is one of the most widely read forex sites on the web. Winners Edge Trading has trained thousands of people to trade the Forex markets.

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  • Geoff

    What are you stuttering about?  No-ones insterested in your personal problems and indecisiveness. If you’re not interested in forex go and read a woman’s gossip magazine, they will be interested in your empty headed comments

  • Please share the strategy I would love to back test it.

  • Cecilia

    Hi Casey,  I am very new so just learning how to trade,  I do appreciate your tips on back testing and strategies,  could you please explain  what you mean by ” If the Entry candle is larger than +50 no trade and Trail Stop by 27 MA candle after the price gets past +30″. Thanks

  • VA

    Bloomberg has a BT function to back test certain default strategies.

  • Kathy

    This is a promising strategy. I like that multiple indicators are used to determine exits/entries. In my experience, this type of strategy is most successful over the long term. However, as someone else mentioned, testing one month of data with one pair is not a statistically valid backtest. For example, I backtested a parabolic strategy for six months and it was extraordinarily profitable. However, when we went live, it blew out the account in six weeks. Market conditions change and strategies need to change with market conditions.

  • Hendrik Schoultz

    Thanks Casey,

    Unfortunately the charts, as appearing with your email teachings on back testing , I find too small to examine in detail.  Even by increasing screen display to maximum does not make much difference.

    Thanks for the advice, nevertheless.
    Hendrik

  • Kesuma

    Thank for your free strategy ,

    kesuma

  • Rblaz18

    sweet, Casey.. thanks for the posting

  • Kwaters

    Is it best to do this manually as done here, or is there somewhere you can automate the back testing. Thanks.

  • Anonymous

    thank u as ever,…u r great.with you in trading world one is not lost.

  • Myproxy

    2 months backtesting, imho, is nothing. And, what i never understood, is, why a working strategy should work exactly on one pair. Anyway, i was not able to find a profitable strategy (ok maybe i had some, but i was unsure,,, and put them away for later review) … so its difficult to believe in something magic really working. But, i enjoyed to read your report. Pitty, dont have the time right now, takes dedication to develop, trst, analyze, improve,,, to dig for new strategies. I earn better and saver providing services to companies. But maybe, when i saved some money (or i find a sponsor) , i’ll return to that arena. Regards, ud … btw, what gave me a kick lately, was, when i analyzed olsen’s scaling laws, if you want to dig into that.

  • Arnaud Nymus

    Nice idea, well done. You could have mentioned that one of the benefit of a good backtesting is to get confidence with the system, be aware of the drawdown and hence don’t give up !

  • Moomstone2000

    Thank you for sharing your strategy.
    Malik

  • Hi5spice

    Hi CASEY,
    Thanks for the free strategy, but i didnt understand……If the Entry candle is larger than +50 no trade……can u please elaborate more on this.

    Many Thanks
    Praks