By: ForexTraders.com
As the popularity of forex trading has surged in recent years, leading more and more retail traders to learn forex online, so has the proliferation of automated forex systems, expert advisors, forex robots and legions of related products.
What we have found is that some of these products work well for a limited amount of time, some never work and others are consistent performers over the long haul. When it comes to automated trading systems and forex robots you can evaluate 10 or 20 of these products and find few similarities between them. Sure, they are intended to help you make more pips, but beyond that, there is little in the way of commonalities.
One thing that these automated forex systems do have in common is that they all tell you about the profitable results they've accumulated. That's a pretty common sales tactic. After all, the purveyors of these products have to have some hook to get you interested and if they can illustrate that their product produces stellar results, it will normally grab the attention of more than a few prospective buyers.
Of course there are plenty of traders that eschew pre-built automated systems altogether, choosing to use a platform like Meta Trader to develop their own mechanical trading system. No matter what system you decided to go with, one you developed or one developed by someone else, that system is going to be back-tested.
Back-testing is simply the act of taking a system's strategy and applying to market data that has already occurred. Think about that for a minute. The only way to test the efficacy of a trading system is to use old data. It cannot be argued that patterns repeat themselves over and over again in financial markets, but that doesn't mean that backtesting is a fool-proof method of discerning how good a trading system is.
The reality is backtesting can be quite deceiving. Traders need to identify what length of time the backtest encompasses. If the backtest only includes six months of data, it might make the forex system profitable under one set of market conditions, but vulnerable once the market changes.
The other side of this coin is that backtests can reach too far into the past and study market conditions that may never be repeated again or scenarios that only come up once every few years.
Another knock on backtesting is that it doesn't take into consideration the random nature of the market. If there was a way to explain why a currency moves the way it does, there would be a lot more successful traders. Backtesting is good for pattern identification and spotting trends, but the results generated by a backtest don't always include quick price spikes or drops that are often prevalent in short-term trading.
The bottom line is backtesting isn't going anywhere because it's easy to use and easy to explain. In addition, since no one has the benefit of a crystal ball, the only way to test any trading system for any asset class is with historical price data. That said, backtesting should not be the only data point you rely on for testing the virtues of your trading system.
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