Whether you’re using a self-developed Forex strategy or a pre-packaged solution, it’s important you test it before putting your capital on the line. Testing not only helps traders become comfortable with the system, but also best determines whether the new system is a reliable winner.
It’s no different from test-driving a potential new car. Test-driving helps determine whether a vehicle will meet your needs, that you felt comfortable behind the wheel, and that it performed as expected.
It’s completely inadvisable buying a new car without taking it for a test drive first, and the same is true for new Forex strategies. Testing builds your confidence in the trading system, you learn how the system works, you familiarise yourself with the precise rules of the strategy, and most importantly, you find out if the strategy is going to be profitable in current market conditions.
How to Test a New Forex Strategy
Testing new Forex strategies is simple enough. First, the trader has to study the system. For a Forex strategy to be consistently profitable, the trader must follow the rules precisely. That’s why it’s so critical to learn what rules must be met for a position to be opened or closed before starting.
Once you’ve developed a level of comfort with the strategy, you can begin to carry out testing. You have two options: demo testing or live testing using a small amount of capital. When you move to live trading, start with a small investment, and then as you continue to test you can increase the amount of each position.
Finally, it’s important that you record all of the pre- and post-trade steps in your trading journal. Recording the process of a new strategy will help you examine what works, what doesn’t and, ultimately, help you prevent errors from happening in the future.
Measuring the Results of Your Tests
As the goal of testing new Forex strategies is to determine their profitability over time, the size of your test matters. The more trades you can make, the more accurate your results will be. That’s why starting in a demo environment before moving to live trading is ideal for novice traders; it instantly increases the sample size.
Through your testing, there are a number of points to consider. Overall, you should focus on potential profits of a particular system over time. Consider these points:
- Net Profit: This is the profit (or loss) made on all your trades over a specific amount of time. However, this number of can be misleading; for example, using higher amounts of leverage can maximise profits in the short-term. The best way to prevent this is by counting your profits irrespective to leverage, that way you have a more accurate picture of the system’s profit potential.
- Wins and Losses: At the end of your tests, count the number of winners and losers and then determine what percentage of trades were winners. This is particularly important for swing traders that benefit from a higher winning percentage. Additionally, consider the maximum number of consecutive losses from the test. Some systems might endure long strings of losses, before producing a large win.
- Length of Trade: Some systems take longer to open and close than others. Determine the time that each trade stayed on the market. Short-term traders that rely on having access to liquidity will likely prefer a system with shorter cycles.
- Profit-to-Loss Ratio: The Profit-to-Loss ratio is a critical measure that every trader should know. In general, most experts recommend a P:L ratio between 2:1 and 3:1. This means that the potential profit is 2 or 3 times that of the potential loss of a specific trade. In addition to P:L ratio, you should also consider the system’s average profitability per trade – the average profit or loss per trade.
The key to successful Forex trading strategy is testing. Before you get started with a new system, take it for a test drive, figure out how it works, and make sure it’s the right trading strategy for you.