Backtesting forex strategies

The question that every forex trader who follows the technical analysis always asks himself in his trading activity is what are the most performing indicators. Understanding which of them guarantee better performances and higher profits is essential to be able to select them, so as not to focus on indicators that do not guarantee good results. In order to select the best indicators, a backward analysis technique is used, which is called “backtesting” (retroactive test). The goal of backtesting is to use time series and measure how much a trading strategy has been profitable. The idea is that if an indicator has been well-performing in the past it will also be well-performing in the future. However, this is by no means a guarantee of future success and the results of this analysis should therefore be handled with care.

In order to perform a backtesting it is necessary to have different information. First of all, it is necessary to choose a trading strategy, or strategies, that you want to analyze, starting from the choice of technical indicators (MACD, Bollinger bands, pair trading …). Secondly, the currency pairs to be tested and the time horizon to be considered must be selected. For example, we want to backtest the euro-dollar exchange rate in the last 5 years of time, using Bollinger bands, the Ichimoku Kinko Hyo and a moving average as strategies. In addition to having technical indicators, it is necessary to select the right strategy that exploits them, setting the rules for entering and exiting the market. An example of a trading rule is one that suggests going long when an indicator exceeds a certain value and short when it falls below another.

Once these variables have been selected, an invested capital and a leverage to be used must be assumed. Once this is done, the actual test is carried out, running the selected strategies on historical data and measuring the results in terms of pips earned, number of transactions concluded profitably and not profitably and maximum drawdown. The analysis of the combination of all these elements allows the trader to formulate opinions about the profitability of single strategies or combinations of strategies. The positive judgment will not necessarily depend exclusively on the profitability obtained. The judgement could also depends on other trading goals, taking into account the level of risk, the time a trader can devote to his activity, and the capital invested.

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