Home
>
Currency Trading
>
5 Questions You Need To Have Answered Before You Back-Test Your Forex System

5 Questions You Need To Have Answered Before You Back-Test Your Forex System

As 90-95% of new forex traders lose money within the first 3-6 months this article helps to guide new forex traders by asking 5 questions that the forex trader needs to know prior to back-testing their forex system.

Let us jump right in...

1. What data type are you using (or going to use)?

I know this sounds strange, especially if you have experience from another market such as stocks as their generally is only one type of data source available. However, in the forex market you can have up to 4 different data types: bid, ask, mid and indicative. Each have their own little nuances.

If you would like to know more about the data types then visit the article written about the perils of . As this will save me from having to repeat the information again and boring those who've already read it.

So, if you know you have indicative prices then you know you're in for some good results! However, if you have any of the other three you need to be careful on how stop and limit orders are placed.

As an example: If we had bid price history and we were looking to place a buy entry stop at 0830 EST according to the day's high, then we know that the bid price will not accurately reflect what the actual price of our order should be. You would have noticed that if you placed a buy entry stop at the exact same price as that of the day's high you would have entered prematurely - you would have entered 4 or 5 pips before the high or the low of the day was touched (the exact same amount as the spread your broker offers!).

This leads me into the next most important question...

2. What spread is your broker offering on the currencies you are bask-testing?

You need to know this as this can help you set your slippage settings on each currency.

As our example in question 1 pointed out. We found that our buy at the day's high method did not exactly work because we bought at the BID PRICE high, not the ASK PRICE high - the price that we need when we place our order TO BUY.

Therefore, we enter in a slippage setting representing the spread that would be exhibited by this trade on this currency.

But knowing at what price to buy is only half the problem... how do we know what quantity to buy?

3. What margin does your broker offer?

If we know at what price to buy our currency at we need to inform our broker on what quantity to buy to fulfill the order. We only know what quantity to buy by the margin that the brokerage firm offers.

Most brokerage firms offer 100:1 leverage, however, some firms offer mini accounts with 200:1 leverage, others only 50:1 leverage.

Find out the margin required.

4. What restrictions does your broker impose?

Now, I don't just mean margin and spread restrictions as I have mentioned above. These are important in their own right, what you need to find out are the details.

This is probably the most important question of all as the fine line between success and failure can be found in the details. Now you can have this questioned by one of two ways: 1. You can find out through experience (generally the most expensive way unless done through the demo account!); or 2. You ask your broker (the cheapest and best way).

Why is this so important? I hear you ask. Well let's say you have a system that trades any gaps that might form on Sunday at 1700 EST, but your broker does not open until 1730 EST. You either need to factor this restriction in to your system, or move onto another system completely. Or, you may have a system that has 10 pip stops, but you find out that your broker will only let you place 15 pip stops from your initial entry price. Once again you will need to change your system to see whether it still performs well, or throw out your system (or change your broker)!

In fact one of the most devastating restrictions imposed by FXCM is that they do not accept stop entry orders if price never happens to trade at your entry stop price! FXCM will honor and "take the loss" of your OPEN stop positions, but if the liquidity is not there and price has shot straight through your stop price then you will miss out. This can have disastrous effects on your system results as you are left wondering on trades where you made good returns - "Would FXCM have got me in?". You may want to of some of the quirks I use when placing entry stop orders on FXCM that could be of huge benefit to you to help you possibly get around this problem.

The restrictions by your broker are only half your systems' success, you also need to find out about another more important restriction... yourself. This leads me to the final point...

5. What restrictions do you have?

This is a vitally important question. Most people test their systems and fall in love with the results but find when they trade their system they have lost their account and that most of the best signals occurred while they were sound asleep!

As the forex market is a 24 hour market, you need to put into place restrictions in your system that will be realisticly conducted by you during the course of a normal trading day. There is no use operating a trailing stop method that changes your stop points during times when you are asleep and cannot possibly do so.

I hope this article has made you aware of some of the important things that need to be known prior to testing your system.

Article written by Ryan Sheehy from . Where you will find reviews on forex data vendors, signal providers, brokers, and popular forex resources, along with more quality articles... all for f*ree!

In The News:

Two Principals of Foreign Currency Trading Firm Sentenced for $17 Million ...
LoanSafe
by Evan Bedard on February 3, 2012 in Scams (Source: FBI) â€“ CHICAGOâ€”Two principals of a foreign currency trading firm that collapsed in 2007 were sentenced to 17 years and 12.5 years in federal prison, respectively, after pleading guilty to fraud ...
2 sentenced for stealing millions in fraud schemeHarrisburg Daily Register
Feds: 2 sentenced for stealing $17 million in fraudChicago Tribune

all 33 news articles »

Argentina Sends Tax Agents to Control Currency Trading
Wall Street Journal
Among other things, the government required people to prove that they had legally acquired the cash they wanted to exchange for another currency. The restrictions cut currency sales at banks to around $50 million a day from between $150 million to $200 ...

and more »

FOCUS: Technology Buoys Retail Currency Trading, Reshapes Old Models
Wall Street Journal
By Eva Szalay Of DOW JONES NEWSWIRES LONDON (Dow Jones)--Retail foreign-exchange trading is emerging as one of the biggest growth areas in the currencies space, and some of the trading firms that facilitate these flows are building up a whole new ...
Ex-Barx architects unveil MahiFX retail platformFX Week (subscription)

all 2 news articles »

Business Recorder
Euro Declines as Greek Debt Stalemate Increases European Crisis Concern
Bloomberg
The 17-nation currency dropped against all of its most- traded counterparts except for the Swiss franc, which declined after touching the highest level since the central bank acted in September to stem gains. The yen rose to almost a record against the ...
Dollar erases gains against euro after US jobs reportWashington Post

all 180 news articles »

Speculators On CME Shave Net Short Euro Bets 8%-CFTC
Wall Street Journal
By Chana R. Schoenberger Of DOW JONES NEWSWIRES NEW YORK (Dow Jones)--Speculative traders pulled back last week on their bets against the euro, wagering a net $25.8 billion that the common currency will continue to decline against the dollar, ...

and more »

Business Insider
Death penalty announced for "disruptive" currency traders
Payvand
The head of Iran's judiciary announced on Wednesday that the courts will readily "issue death penalties" to the "disruptors" of the country's foreign currency market. Black market currency traders have remained active despite government ban.
Iran Announces Death Penalty For 'Disruptive' Currency TradersEurasia Review

all 16 news articles »

Currency News
Foreign Exchange Rates : Currency Predictions - GBP, USD, EUR, TRY
Currency News
Given the weak nature of these numbers and the continued absence of a debt deal from Greece, next week could see tough trading conditions for Europe's single currency. NEAR-TERM OUTLOOK â€“ NEUTRAL TO NEGATIVE. The Lira has made a storming comeback in ...

and more »

US Dollar Risks Collapse On Dow SurgeÃƒÂ¢Ã‚â‚¬Ã‚Â¦If This Is A True Risk Rally
TheStreet.com
By DailyFX 02/03/12 - 09:14 PM EST By John Kicklighter, Currency Strategist There is little debating the greenback's immediate trend. In approximately three weeks the Dow Jones FXCM Dollar Index has dropped nearly 360 points or 3.6 percent â€“ a ...
Dollar at Risk of Fresh Plunge as Dow Moves to Test Multi-Year HighsDailyFX

all 11 news articles »

RBC wins top currency forecaster title in January
Reuters
The Reuters one-month euro consensus in January's foreign exchange poll was for the currency to stay bound to its December close of $1.295. The euro also received a boost toward the end of the month when the US Federal Reserve unexpectedly signalled in ...

and more »

Risk.net
Thomson Reuters Foreign Exchange Volume Tops EBS
Wall Street Journal
T) handled more foreign exchange spot market trading volume than its main rival EBS for a third straight month, according to new data released by the two companies Friday. Thomson Reuters benefited from a shift in trading volume to currencies driven by ...
Icap's forex e-trading platform to offer outright forwardsRisk.net

all 12 news articles »

Google News