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The Importance Of Strategy Testing

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Creating a successful, consistent and profitable trading system is the aim of any forex trader, however, it can take years of experience and practice to actually come up with one, not to mention the fact that even a strategy that was once successful, won’t always be.

If you have traded for a while, you know what making consistent winning trades means that you can’t just look at each trade completely fresh, you need to have a set of boundaries and rules that you have put in place, not only to find the best trades but to also act as protection for your account, otherwise known as risk management.

So let’s say you have come up with a new strategy, on paper, everything looks good. It takes into account pretty much everything you can think of and you can see no reason as to why it won’t work, you just jump straight into the live markets with it right? No! You need to test it, and there are a number of different ways that you can do this.

Before you do any sort of live testing you need to ensure that your strategy would survive something called a backtest. This is a way of looking at the historical data from the markets, looking at how they moved and applying your strategy to what has happened in the past, if your strategy holds up well then it shows that it offers a bit of resilience, however, if the backtesting shows times where the strategy would have blown or had a large number of losses in a row, then it may need a little tweaking to sort that out.

If the backtesting all passes, then there is one very important aspect of testing that is required, demo it. Using a strategy on a demo account lets you test it out in real-time on market conditions that are very similar to the live markets. The key to using a demo account is that there is no risk, you are able to test it out, it if brings a few losses, you can adapt it to fix whatever aspect caused the loss and then continue to test, this should be done for an extended period of time, months for proper safety and through multiple different market conditions such as trends.

When testing the strategy there are a few other aspects that need to be tested, no strategy is 100% bulletproof, so looking for the signs in the market where your strategy won’t work is just as important as getting it to work. Maybe the strategy won’t work during major economic news, maybe it only works in an up or downtrend, these are the things that testing lets you work out and then once going live will allow you to avoid such events when using your actual capital, this acts as another form of protection for your account.

The main downside to testing is that it lacks some of the things that you get on a live account, things like slippage and commissions. These can really impact your profitability especially if your strategy looks at taking lots of small profits. So keep this in mind when testing, be sure to subtract an amount form the figures given in order to account for these.

The more testing you do, the better your strategy will be. We know that it can be a little boring going over the same thing over and over again, you also want to get that strategy trading live, we understand that and always feel the same way. However, diligent testing is the only way you can be sure it will be profitable and is a vital part of creating a new strategy. If you want a strategy to be profitable, it needs to be tested thoroughly.

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