Part 4 Creating the First Forex Strategy – How to Fine-tune Your Strategy (Manual Backtesting)

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Part 4: Creating the First Forex Strategy – How to Fine-tune Your Strategy (Manual Backtesting)

The so-called backtesting, or testing of your trading strategy, is the alpha and omega of the entire trading business. Only at this final stage will you find out if your strategy really is profitable or not. Let’s start from the beginning though. I’ll show you what backtesting is, how it’s done and what you can learn from it.

I’ll even show you the results of my own backtesting. So, let’s do it.

What is backtesting?

Backtesting is the testing of a certain trading strategy based on historical data, and thus, the verification of profitability on real price movements from the past. So, consider a graph for the last year. From the graph, you can read the moment you’d enter the trade and how it would have turned out.

Why is quality backtesting so important:

Trough high-quality data, a representative sample, you will learn how the strategy would have turned out if you had already used it – a year, two, three, or maybe ten years ago. At the same time, you will find the trading strategy’s greatest weaknesses, learn what could be improved, where to set a stop-loss and when to take profit.

Your trading strategy should be built on a logical basis. However, only backtesting can fine-tune it and adapt it to your chosen instrument. While one strategy may theoretically work on a pair of EUR / USD and gold, it will hardly have the same parameters for taking profit or stop-loss options. And these are the determining values.

How to perform backtesting

First of all, you will have to come up with a trading strategy or at least with some sort of an idea of a strategy (I will provide you with one below). It is up to you whether you use automatic testing in the form of a strategy tester or another tool, or if you choose to do it the old fashion way, using just pen and paper (although today you may want to use Excel instead).

The different testers are great, as they provide very quick results of your strategy on basically any data sample. After all, you can check out our older article about the strategy tester in MetaTrader.

Personally, however, I think that automatic testing is not free of certain obstacles:

You must be able to rewrite the strategy into orders according to the appropriate convention

  • Not everything can be entered into the system
  • You lack visual control and experience
  • You must be able to rewrite the strategy into orders according to the appropriate convention

You may have a different opinion on this, but personally, if I don’t want to create an automated trading strategy, I prefer to go through the trades one by one. Why? Because in the end, it will be me who will enter the trades again, not the computer.

Benefits of manual backtesting:

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  • Trading strategy experience
  • Visual recognition
  • A better experience with market behavior
  • In general, a lot of “seen graphs” and experience

With backtesting, it is the experience with the trading strategy, its easy visual identification and the experience with the given market that is priceless. A quality backtests can provide you with an incredible amount of experience, which you’ll surely appreciate in real trading, where a slight nervousness comes into play.

Example of backtesting

Personally, I am a fan of simplicity, and so in my repertoire, you can find even some very primitive trading strategies, for example, a very well-known strategy for filling the gaps when the market is closed. In the forex, this usually means the weekend.

I backtested this strategy early in 2020 and decided to check 100 trades back to EUR/USD. I had only one condition -the gap being greater than 5 pips, otherwise, it was not even worth entering the trade due to fees. Take profit was set to fill the gap and stop-loss to unclear.

I wrote down the results three times, if the stop loss was 10, 20 or 30 pips, to see what would perform better.

Example of recording during backtesting

I went through each trade, one by one, calculated the difference between the opening and closing price in points and wrote down the results in Excel. From this I got this result:

The backtesting results

The chart above shows that the strategy was profitable in all cases, but the biggest profit came with the SL = 10 pips setting(take profit always fill the gap).

Then I calculated the trade costs, found a broker with fixed fees and finally subtracted 200 pips, still leaving with a decent profit of 208.5 pips on 100 trades. I could declare the strategy profitable and start trading it. This was 5 years ago, and to this day I am still trading using the very same strategy.

This strategy is not one of the best strategies in the world, but it is profitable.

I’m not forcing you to trade with this strategy. I just wanted to show you the way and, specifically, my way. Although I liked the simple idea, I didn’t trust the strategy. It just seemed too simple. So, I tested the strategy on historical data and determined which stop-loss was the best.

Although it may seem easy, even such a simple backtest as the abovementioned can swallow your whole afternoon. However, it pays off, as the experience gained is priceless.

Author

More about the author J. Pro

Unlike Stephen (the other author) I have been thinking mainly about online business lately. I wasn’t very successfull with dropshipping on Amazon and other ways of making money online, and I’d only earn a few hundreds of dollars in years. But then binary options caught my attention with it’s simplicity. Now I’m glad it did because it really is worth it. More posts by this author

Part 3: Creating the first forex strategy – 5 common mistakes when creating strategy

The trading strategy is not just about opening and closing trades, but primarily about trading morale and rules. Most often we are mistaken when it comes to the rules.

These mistakes are the main reason why most traders are losing trades. Take a look at these mistakes with us and possibly also at the alternative in the form of copying trades.

Mistake No.1: Demo Account vs. Real Account

Timely transition to a live account is critical. To be clear, we don’t want to say that the demo account (when and how using forex demo) is useless, because it is certainly not, but most traders stay on it for far too long.

At the demo account learn how brokers trading platform works and backtest your strategies, meaning test new trading strategies on your demo account.

If you start trading from scratch, you can spend the first two, maybe even three months on a demo account, but then you probably should switch to a live account and continue trading with your low-risk strategy. Of course, keep the demo account, continue to use it for testing new ideas, strategy improvements, etc. Consider the demo account a testing environment in which your new trading strategy must always be approved.

Why switch to a live account as soon as possible?

The fact is, if you want to make money, you cannot do so on a demo account. Above all, however, your live account will make you learn how to deal with your emotions, and you shall see whether you are able to follow the trading strategy and thus gain valuable experience. See for yourself what a huge difference in trading real money maker.

We should probably slow down a bit at this point. At the beginning of your real money trading, sign up to your live account, where you can trade micro-lots or nano lots. This is really the smallest possible trading volume, and though you will not get rich trading with these, you will already begin to understand the trading psyche. There is usually no dramatic loss in these low volumes as losing a few hundred crowns is nothing that you should not be able to withstand. Your money will provide you with a relatively inexpensive useful experience.

In a nutshell, transfer to the live account early and start trading in the smallest of volumes, then increase them in proportion to your deposit and the risk you’re willing to take.

Mistake No.2: Finding reasons and data overload

Most traders (and not just the beginners) are constantly trying to find out why some movements have happened, and why other ones did not. It is important to realize that listening to Bloomberg and even reading all the news cannot give you the answers that you seek. Sometimes, the market simply does not behave as we would expect, which is especially true in the short-term view. Likewise, a strategy with ten indicators does not have to be better than a strategy with three.

If you can accept that you cannot explain everything, but your strategy is still meaningful and statistically confirmed, you have won. If you just want to analyze everything and be some kind of a walking Wikipedia, good luck with that. You may become a perfect trader someday, one who will understand the complexity of this big carousel, but honestly, you are much more likely just to get a headache.

Mistake No.3: Impatience and Losses

This subject is very important as it actually follows the first paragraphs where we discussed the difference between a demo account and a live account. On the live account, time seems to pass differently for some reason. You can spend an eternity waiting for a trade to open, and after it’s opened, you are forced to wait yet again; You may be in a loss or around zero for a long time – suddenly there is a small profit, so you decide to end it. But by doing so, you violate your trading strategy and you will not have sufficient profits to cover your losses. And the losses are the big scarecrow that causes the very problem.

At this point, it’s all about the psyche, and psyche can be trained on the live account. The beginnings are hard for everyone, so if you don’t get it right immediately, don’t worry, and try to learn from your mistakes.

Mistake No.4: Trading Strategy

How many traders have a trading strategy? And how many of them have it in writing? It doesn’t matter if it’s printed on written by hand. Or who has at least the basic trading morale rules written down? Most of you will say that you have these in your head, but what are you thinking about when you are losing a trade? Definitely not some trading rules and strategies. If you write it down and consider it “holy word carved in stone,” it will become your order and your support. It really does help a lot, so don’t underestimate it. As for the trading strategy itself, it is ultimately the last problem.

We shall advise you on this subject in our forex trading strategies category.

Mistake No. 5: Starting with the hardest

Many traders start trading at the stock index or focus on the forex market – or currency pairs. That typically means EUR/USD. Such instruments are already quite challenging, but to make matters even worse, traders sometimes resort to scalping or intraday trading.

It’s definitely a way of trading, no doubt, but it is probably the hardest combination that you could counter and to start with the hardest is not recommended … We won’t force you into anything, it’s up to you. But to start with less volatile instruments or at least swing trading seems to be a better option. However, it is of course up to you and you can definitely earn on any instrument offered in any time frame.

TIP: Trading signals copying

If all this made you head spin, but trading is still tempting you, choose (at least in the beginning or as one of the diversification options) trading that is copying someone’s trading strategy.

For example, eToro offers this option. It is a reliable broker with positive ratings and many traders all around the world.

Once you open a real account, you’ll see strategies that you can copy. For each strategy, you see its history, its profitability, but also all fees, such as the strategy fee to the provider (the owner of the strategy you want to copy). In general, you pay an entry fee, a management fee, and a profit fee. But some of these fees can mount up to zero. To learn more about coping strategies read article below.

Copying trading orders is definitely a good way to go. In addition, someday you can also move to the other side and become a strategy provider yourself, earning money on the trust of other people. To get there, however, you need time. Rome wasn’t built in a day.

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Author

More about the author J. Pro

Unlike Stephen (the other author) I have been thinking mainly about online business lately. I wasn’t very successfull with dropshipping on Amazon and other ways of making money online, and I’d only earn a few hundreds of dollars in years. But then binary options caught my attention with it’s simplicity. Now I’m glad it did because it really is worth it. More posts by this author

When and How to Use a Forex Demo Account

Though being a useful helper, forex demo accounts can also cause harm. Today, I’ll show you what is the prime purpose of the demo account, how to use it and when to migrate from a demo account to a live account. Let’s get started.

What is a demo account

These days, a demo account is being offered by almost every forex broker. Demo accounts are virtual accounts with virtual money which is connected to a real trading platform, receiving real data on the market.

That means you can open and close trades and it won’t cost you a single dollar. Even though, your trading commands are not really sent to the market, you will not recognize any difference.

Demo accounts realistically simulate real trading. At first sight, the only difference is money – real vs. virtual. However, if you look at the issue in more detail, you will find out some more.

When to use demo account

Using a demo account comes handy in two situations. First, when you are a beginner. If you are not familiar with forex trading you should start with a demo account. You can test the trading platform and learn the basics of trading. The most popular trading platform is Meta Trader 4.

The key is to be able to control the trading platform. It should never happen that you trade with real money without knowing when and how to open or close a trade etc. Because real money generates more stress and pressure, you must always exactly know how to open and close a trade, how to set your take profit and stop loss. With a live account, all the steps must be done quickly and without a mistake. There’s no time to hesitate and look where to click and what to do…

Once you become familiar with the trading platform and have at least the basic grasp of trading (trading volumes, tick/pip, e forex trading strategy etc.) stop using your demo account and progress to real trading.

It should be emphasized that forex is affordable to everyone. Real micro forex account is something even students can afford. Anyway, all traders should take their first steps with small amounts of money.

Because demo accounts can’t teach you the psychological aspects of the business and because trading with a demo account for too long makes no sense. After about a week or two of using a demo account, you should migrate to a live or real trading account. If you suffer a loss, it will not be any disaster, perhaps a few dozens of dollars. The experience and lessons learned will give you more than a year of trading with a demo account.

Above we mentioned two situations in which demo accounts can be beneficial: One was the beginner stage. The second one is the testing of new trading strategies and new markets i.e. currencies, commodities etc. As an experienced forex trader, you will surely have at least one demo account as a backup.

Differences between demo and real accounts

So far, it has seemed that the only difference between a demo account and a real account is money. Ideally – with a good forex broker – it is. Sometimes the demo account is optimized which in many cases is justifiable. During volatility peaks, typically following various meetings or press releases made by central banks prices tend to fluctuate. During such periods it is difficult for a broker to process a trading order, which might be delayed or rejected by a real market.

With a demo account, you will not experience this problem. The fact that in some cases your real account is slower than the demo account might be caused by some unfair practices such as a set delay on your account. With a solid licensed and regulated broker, such problems don’t exist. Therefore, it is crucial to find yourself a reliable forex broker.

Demo accounts can help enormously and we recommend that you all use them. Nevertheless, be aware that the demo account is not a tool to be used in the long run. Even a small real account with a few dollars and the experience when using it will give you much more.

Verified brokers offering demo account

As mentioned above, demo accounts are offered by all reliable brokers. After opening the website, simply press “Open demo account“. Our list of tested brokers offering demo account includes the following:

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Author

More about the author J. Pro

Unlike Stephen (the other author) I have been thinking mainly about online business lately. I wasn’t very successfull with dropshipping on Amazon and other ways of making money online, and I’d only earn a few hundreds of dollars in years. But then binary options caught my attention with it’s simplicity. Now I’m glad it did because it really is worth it. More posts by this author

One Response to “When and How to Use a Forex Demo Account”

Post a detailed video of how to use demo forex account. There is no single video on the net showing clearly about demo.

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