Backtesting Software for Forex
At this stage, some traders might wonder why the use of backtesting software
might be helpful for market participants. Here it is important to mention that despite its perceived complexity, this can be a handy tool for traders, due to following reasons:
- By utilizing backtesting, traders can check the effectiveness of dozens of Forex trading strategies. It might take weeks or even months to achieve this by only using demo accounts. However, with the help of backtesting software, market participants can assess the strengths and weaknesses of several trading techniques in a relatively short amount of time.
- Backtesting software shows not only the relative effectiveness of different strategies but also the actual amount of gains and losses in dollar terms. This can certainly help traders to set realistic daily and monthly targets for their payouts.
- Those types of software also allow traders to choose from the list of dozens of currency pairs. Therefore this gives them the opportunity to identify which currency pairs work best with their favorite trading strategies.
- By identifying and discarding ineffective Forex techniques, traders can cut the amount of their expected losses considerably. This can also help market participants to improve the ratio of winning trades.
Utilizing Forex Backtesting Software 2020
For some Forex traders, especially for beginners, utilizing backtesting software might sound like a rather complicated task. However, here it is important to note that this is not necessarily the case. One does not need to go through some specialized training in order to operate Forex manual backtesting software. Instead, the entire process involves just several steps.
Moving on to practical examples, let us discuss how Forex backtesting software MT4 works. Firstly, a trader needs to log in to the MetaTrader 4 account. As the platform opens, an individual will see the following components on the menu:
So in order to utilize this tool, traders need to select the ‘View’ category and then select the ‘Strategy Tester’ option on the menu. Alternatively, market participants can use Ctrl+R keys as a shortcut to get access to backtesting programs. After selecting the Strategy Tester, the following menu will open:
As we can see from the above screenshot, there are a number of settings to choose from. Therefore, in order to avoid confusion, let us discuss this one by one, starting from the upper left corner of our image and moving downwards:
Indicator vs Expert Advisor
Here traders can choose how the computer will execute trades on backtesting. One option is to use an expert advisor, which tries to combine several indicators. However, for more specific analysis, it might be a better option to choose the Indicator option. In this case, the computer will focus on one specific indicator and base its trades and results on this one measure.
If in the previous case traders choose ‘indicator’, then here they are able to specify which indicator they wish to use. The selection of those is quite large, it includes moving averages, accelerators, Heiken Ashi, and many others. This allows individuals to test the use of different indicators with the same currency pair and compare the effectiveness of each of those.
On the other hand, if traders choose ‘Expert advisor’, then they get to specify, which method artificial intelligence will use to make trading decisions. The default choice here is ‘moving average’, however, there are some other options as well.
Symbol and Model
Next comes the ‘Symbol’ category. Here traders can choose the security in question. This can involve not only the currency pairs but also the prices of commodities, such as gold, silver, oil, and even some of the most famous stock market indices.
This is followed by the choice of the ‘Model’ category. This essentially involves the choice between 3 different options. ‘Every tick’ option offers the most thorough and reliable analysis of a given security. This is ideal for the purpose of formal research, as well as for making some important trading decisions. The only downside here is that the analysis might take a considerable amount of time.
In comparison, the ‘Control points’ option is a relatively faster method, however, it does state that the result should not be considered. So it seems that this option is for the purpose of getting a general idea about some particular Forex strategy, rather than quoting the data for some research publication or using it in the decision-making process.
Finally, ‘Open prices only’ option offers the quickest method to analyze the currency pair. The downside to those quicker options is that the speed somewhat diminishes the quality and reliability of the analysis. So this option is for demonstrative purposes only.
Data and Period
Next on the list, we have data: If traders tick this box, they can modify the period, covered by the test. On the right side of the data box, there are two dates, representing the beginning and the end of the period in question.
The choice here is considerably large. Here traders can only choose to analyze one day’s worth of data, or alternatively the price action, stretching for 10 or even 20 years. One thing to be aware of here is that analyzing large periods, requires much more time, even for the best Forex backtesting software.
This is a useful addition to the software since it allows traders to maintain the rest of the setting and conduct several tests covering different periods in the same currency pair.
On the right side of the ‘Symbol’ category, we have the choice of period. Here traders can choose the timeframe on the chart for testing. This includes standard time frames such as 1, 5, 15, 30-minute, 1, 4-hour, and daily charts. This gives market participants an ability to compare the effectiveness of the same strategies with different timeframes.
So for example, it might happen that one particular Forex trading technique might fail the test with 5-minute charts. However, on the other hand, it might produce some very successful results with a daily time frame. Therefore, it can be a good idea to test each of those strategies with different periods and to observe if it makes any difference.
Spread and Optimization
Next category just below the ‘Period’, we have the ‘Spread’ category. This takes account of the broker spreads in the analysis, to make results more realistic. Traders can choose the ‘current’ option, which uses the current spreads. Alternatively, market participants can specify the amount of the fixed spread, ranging from 2 to 100 pips.
Now choosing the ‘current’ spread options might seem very logical for many traders. However, one thing to keep in mind here is the fact that spreads are constantly changing. In times when markets are calm and exchange rates relatively flat, spreads tend to narrow. On the other hand, in times of increasing volatility, spreads are usually widening. So choosing the ‘current’ spreads might not always produce the most accurate results.
One viable alternative is to check the size of the average spreads for a currency pair in question. This information is freely available on the broker websites. After identifying this number, traders can specify the amount in the ‘spreads’ category. This can certainly help to make the results of the test even more accurate, than before.
Below this category, we have a small box for optimization. This option is only available if the trader has chosen ‘Expert advisor’ at the start of the menu. By ticking this box, a trader turns expert advisor into optimization mode. Here one can specify the priorities of the advisor in the decision-making process, where it will take a balanced approach, maximize payoffs, and many other options. If a market participant chooses ‘Indicator’ at the start, this option is simply grayed out.
Expert Properties / Indicator Properties
Let us move to the right upper side of our image. The exact appearance of the category will depend on the previous choices of the trader. For example, the ‘Expert properties’ category appears only if, at the beginning of the menu, the trader chooses ‘Expert advisor’. Here one can select the parameters that the expert uses in the test. This includes the amount of the initial position, ranging from $500 to $50,000.
Here also the market participants can choose the currency of trading account, so instead of USD, they might decide to conduct analysis with EUR, GBP, or other currency accounts. Here they can also set the optimization parameters, which essentially involves setting some priorities and limitations for the expert advisor.
On the other hand, if a trader chooses the ‘indicator’ option on the left side of the menu, then on the upper right side, ‘Indicator properties’ will appear. This actually makes it possible to modify the indicator properties. Here traders can modify the coloring of candlesticks, as well as that of a chart.
Symbol properties and Open chart
The next two items on the list are for information purposes only and are not modifiable. Firstly, we have the Symbol properties category. This basically opens an information window for a given currency pair. It includes such information as the amount of spreads, daily swap rates, contract size, trading hours, and some other details. This can be very handy for some longer-term traders since they can check the amount they will either receive and have to pay for keeping the position open overnight.
The next section is named ‘Open chart’. This allows traders to open the chart of the security which they have chosen from the ‘symbol’ section. This is a very convenient tool because market participants do not have to search for the relevant chart every time they want to conduct a test with another currency pair or commodity.
Modify expert / Modify indicator
The Modify expert option appears if a trader is using an expert advisor. After clicking this option, it opens a page, where traders have the ability to modify the algorithm of the expert advisor. Here traders can modify such items as the number of trading lots, level of maximum risk, moving period, and other variables. By those changes, traders can adjust the priorities and limitations of the expert advisor and compare different results.
At the same time, if a trader selected the ‘Indicator’ option at the beginning of the menu, then the market participant will see the ‘Modify indicator’ section. Here the trader can modify the coloring of the chart and its candlesticks.
How to Conduct Forex Backtesting Online?
At this stage, many market participants might wonder what are the necessary steps to conduct backtesting and how can they apply it in practice. It goes without saying that the first obvious step in this process is to gain access to some type of Forex backtesting software.
Actually, this can be achieved very easily. Traders can register for the Axiory Demo account
, where they can use Forex backtesting software free of charge. After setting up the strategy tester on MetaTrader 4 account, as we discussed before, traders need to choose the relevant period.
In order to make this more digestible, let us take an example from this USD/JPY daily Heiken Ashi chart:
As we can see from the image above, at the beginning of the year 2020, the USD/JPY pair was trading near the 109 level. For the first 2 months of the year, the US dollar has appreciated steadily, eventually reaching 111 level, during late February 2020.
What we see next is the series of 12 consecutive red Heiken Ashi candles, as a result of which the pair has dropped all the way down to 106.5 mark. It seems that the outbreak of COVID-19 pandemic and the subsequent stock market crash, during March 2020, led to a massive flight to safety in the Forex market. During those times, the lower-yielding funding currencies usually tend to benefit from those trends.
At current rates, the difference between those two currencies is not very large. However, the Japanese yen is still a lower-yielding currency than the US dollar. This is because the US Federal Reserve keeps its Federal Funds Rate within 0% to 0.25% range, while at the same time the Bank of Japan holds rates at -0.1%. In fact, a year ago, USD was much higher-yielding currency, when the US rates stood close to 2.5%.
Therefore, when the risk-off trades started to dominate the market, it gave a significant advantage to the Japanese currency. However, after some weeks of trading, the panic selling in the market ceased. As the situation started to normalize, the US dollar started to recover from this recent decline.
Before the end of the month, the US dollar was already back above the 110 level. However, here it is worth noting that the strength of the American currency did not persist for long. During the subsequent months, the USD/JPY pair dropped slightly, eventually settling within 106 to 109 trading range, the state of affairs, which remains unchanged even to this day.
So traders can run tests to answer the following questions: how did the trades conducted by 50-day simple moving average (SMA) analysis would be performed during this period? Would using the 50-day exponential moving average (EMA) made any difference? How successful would have been the trader if he or she used Heiken Ashi candlesticks as the main source of guidance?
As we have explained above, trades can answer all of those questions, by adjusting the settings of the Forex Strategy analyzer, by modifying the timeframe, the currency pair, the type of indicator, and other variables.
Then traders can take note of the combinations of those strategies, timeframes, and currency pairs, which have shown the best results. Obviously, the old market principle, past performance does not guarantee future performance, still holds true here. However, the Forex strategy which performed well in several backtests is more likely to succeed in future trading.
Imperfections of Backtesting Software Forex Traders Should Consider
Despite all of its upsides we discussed above, it is important to recognize that backtesting software has some imperfections as well. The first issue with those types of programs is the fact that they might not be the most effective methods for simulating real trading experience.
The main reason behind this is the fact that traders might have some specific strategy in mind, however, it is highly unlikely that they will always rigidly follow one indicator regardless of the circumstances. It is much more likely that the market participants will also take the latest economic announcements into account. At the same time, they might combine one technical indicator with several other indicators in their analysis, before making trading decisions.
Therefore, considering those arguments, the Forex simulator might do a better job at simulating the market environment, then backtesting software.
Another potential downside for those types of programs is the fact that they can not take account of the fact that the trading patterns of some currency pairs change over time, due to economic, geopolitical events or other factors. For example, testing GBP-based pairs for the years prior to the 2016 EU referendum might produce some misleading results.
The fact of the matter is that Brexit has made some significant changes in the structure of the British economy. Since this event, the United Kingdom also faces such risks as no trade deal with the European Union and also a very real possibility of the second Scottish referendum. It goes without saying that this high degree of uncertainty can have a considerable negative impact on the pound exchange rate.
Therefore, this is something to keep in mind, when making trading decisions, based on test results, using the MT4 backtesting software.