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 indicative
prices. 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
read 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 Currency Secrets.com. 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!
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