Any source of currency trading information will tell you that you need to test a forex system before you go live but how exactly can you do that? The truth is that you should do it in more than one way.
1. Back Testing
Back testing a forex system involves scrolling through the historical charts looking for situations that would have triggered a trade under your system and recording what would have happened if you had opened a trade at that time.
Historical charts are provided free on many currency trading information websites.
It is very important to apply the rules of your system in a realistic way when back testing. So for example, if you are using an EMA crossover system, you might spot a crossover on a past chart that was followed by a 200 pip rise. Do you write down that you would have made 200 pips from that trade?
No, it is probably not realistic. First you might have spent a minute or two checking the signal against other time periods or other indicators. Most systems require you to do that. In that time the price might have changed.
Then you have to think about where your stop loss would have been and whether there were any fluctuations that would have triggered your stop loss. If there were, you must record a loss even though there was potentially a 200 pip profit.
Lastly, consider where you would have closed the trade. If your system aims for 100 pips profit per trade, you would have closed at that point and missed out on the rest of the price movement.
If your system involves closing half of a successful trade, you will calculate what your actual profit would have been, applying that method.
2. Forex Demo Testing
After back testing, assuming the system looks profitable, you can then test it in a demo account on the live market. This gives another range of valuable currency trading information relating to your system.
Demo testing is still risk free because you will not be using real money, but you are reacting to the state of the market in real time.
Clearly this is a slower process because you have to wait for a trading signal instead of scrolling through past charts.
However, it gives very valuable feedback about how you would actually operate the system.
It is possible to test several systems at the same time in a forex demo account, which saves time. However, it is important to record them separately.
It is necessary also to take into account the fact that operating several systems in real time may mean that you miss some triggers.
On the other hand if you plan to operate more than one system simultaneously when you switch to real money, it is a great idea to do this in demo first so that you can see the effect on your trading.
Testing your system effectively can take some time, but it is time very well spent. While you are testing you will be learning a huge amount about the behavior of the market and your own trading behavior, as well as the system itself.
Traders often forget to take into account their own behavior or trading style, but it is vital to the success of the system and is often the reason why people who follow systems that have worked well for other traders, have trouble making them profitable.
They look for more and more currency trading information but do not see that their own personality has an effect on their trading too.
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