What does backtesting trading strategies mean? Let's have a look at the traders' toolbox. What do you think we are going to find? The trading platform itself along with custom and integrated indicators, information sources with trading basics. What else? A notebook with all trades written there. News and analytics, different types of chart patterns.
Sounds like enough for successful trading. But something is missing. The toolbox should also include the trading strategy that has been worked out to meet your specific needs and trading style. What's more, we need to be 100% sure that strategy is working. This is where backtesting trading strategies will help.
What is strategy backtesting?
The idea is pretty clear. We have a trading strategy and we want to check if it works under real market conditions. To make it simpler, backtesting trading strategies is the procedure that helps to extrapolate the given strategy or hypothesis in the previous time frame. In other words, we do not apply the strategy to the upcoming period and use historic timeframes and data instead. With backtesting trading strategies, we actually go back in time and try to see how the present hypothesis would work.
The main benefit here is that a trader can choose any period with the same features and factors if compared to the represent one and adjust the current trading strategy to the historical timeframe with the same outcome. Sounds very effective but complex. Not until you figure out how to backtest trading strategies yourself.
Types of strategy backtesting
To test the strategy in real-time, traders have two major options. They include:
- Automated Strategy Backtesting – a method that requires writing a piece of code that will automatically put you in accordance with the strategy you need to test. However, this method has no sense for non-technical users and traders who do not know how to code. That's us.
- Manual Strategy Backtesting – it will work for people without coding skills. The idea is to do actually the same as the automated code does but with your own hands.
The second method is more time-consuming. On the other hand, it is not as complex as it sounds. Let's have a look at the example of how to use Backtesting Trading Strategies on MT4.
Strategy backtesting on MT4
As mentioned earlier, we will use a manual approach that fits users with no coding or technical skills. The main concept here is to trade but in the "previous" market. You will need to explore each chart in detail and go bar by bar the same way you do in the live financial market.
So, the main steps to backtest your trading strategy on MT4 are as follows:
- Choose the market you want to trade in.
- Scroll it to earlier times.
- Have indicators and trading tools plotted on the chart.
- Go to chart settings and place profit targets, entry, and stop-loss (make a trade).
- Write down the result of the trade.
- Repeat steps 3-5 until the strategy proves to be effective enough.
Complete backtesting on the powerful and trusted trading platfrom, MetaTrader 4! Here you can download MT4 for free for backtesting strategies right after completing a simple registration form.
Advantages and disadvantages of strategy backtesting
Needless to say, having a successful strategy by your side is a great handicap. On the other hand, strategy backtesting does not guarantee flawless results or huge profits. It is all about market exploring and in-depth analysis just the same way as you do all the time when entering the financial market at present. Besides, you need to keep in mind some crucial pros and cons.
Strategy backtesting pros:
- No technical skills are required.
- No need to code.
- Free to use for any trader despite the platform he or she uses.
- Useful strategy insights and testing results.
Strategy backtesting cons:
- Extremely time-consuming.
- Mistakes may occur.
- Misleading tracking results.
- Limited historical data.
If you use this concept, you will need to be prepared to consider various trading periods, which is hard.
The good news here is that MT4 delivers enhanced functionality. If you are the lucky one to use it, the system will make it possible to pick a chart you want and rewind the time. In other words, you will be able to replay the previous market period starting from any day you like thanks to the "Forex Simulator" feature. You will be able to place orders whenever needed or modify them the same way you do when trading live.
This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.