Forex Trading- Testing Options

Forex Trading- Backtesting Perils: the Dark Side of Automation B

The high risks involved in forex trading have often compelled traders to highly appreciate computer simulations of market conditions where strategies can be tested. Simulations are mostly used in a process called back testing, where the tested strategy is applied to past data by the trading software automatically, and the results are compared and analyzed in order to evaluate the success of the tested method.

But how reliable or meaningful is back testing? In this article, we’ll take a brief look at this subject.

Back testing depends on false assumptions

Back testing is based on the assumption that past performance has a relationship to future results. Yet the most common and basic disclaimer found on just about every broker’s web page states that “past performance does not guarantee future results”. In other words, the past and present are detached in trading, the forex market changes all the time, so do the rules that the market depends on, and as such, it is not sensible to expect a strategy to be uniformly successful in all market conditions covered by a back testing study. Back testing depends on faulty assumptions, and reaches unjustified conclusions.

Inspires false confidence, and sponsors a faulty approach to risk management

Back testing generates wrong results, and inspires confidence in methods that in fact are flawed in principle even before they are tested. Any trader who risks too much on a strategy that has generated exceptional results in back testing is likely to be heavily disappointed in the actual outcome sooner or later.

Test results have only educational or entertainment value

Back testing can be useful as an educational tool. You can learn how indicators work by testing simple constructions that you create, improving your ability to improvise forex strategies as conditions necessitate them. But back testing results can never justify the relaxation of risk controls, because back testing results do not have any relationship with future realized results.

and they will generate disastrous results if used to justify leverage or high risk in general.

You’re free to do whatever you like with your back tested strategies, but if you get carried away and trust them so much that you give up money management methods, or apply them with no consistency, rest assured that the results will be very different from what you had anticipated.

Forex broker reviews can never be substituted for interaction with, and personal testing of the firms by the trader in live trading with mini-accounts. So is the case with forex strategies. You need to test them in live trading, with real money, and take risks that bear rewards when you’re successful. Back testing can never be substituted for trading, because of the tendency of markets to establish patterns that have little relevance to past dynamics.