Back testing an automated forex strategy involves simulating the performance of a trading strategy based on historical data. Goal is to estimate if a strategy would have been effective during the tested period. Many forex robot sellers are not shy with throwing the most amazing back test reports at you in order to convince about the profitability of their strategy.
Is it that easy?
Be careful with back testing results
Back testing is not an exact science and we try to explain why a back test is nothing more than an indication if a strategy might have worked in the selected period. There are many variables that can affect your performance but today we want to show you how market conditions can change the results of a back test.
For example, we back tested a strategy in 2013 and 2014 as shown below
Drawdown is 54%, profit factor 2.67
But, in 2014 it shows much better results in terms of drawdown
Drawdown is 23%, profit factor 2.53
So why do these results differ that much?
Simply because market conditions are changing so when using the same settings as in 2013 the outcome can be totally different. Therefore using a forex robot is not just a matter of plug and play, but a constant monitoring of the market to see if market conditions are changing and adjust settings in case it does. For example, if the volatility increases in the upcoming period (like a Brexit event), it means that prices will move more and therefore you need to change the price triggers accordingly. This takes time and requires knowledge. For this reason an EA is absolutely no guarantee that you will make great performances regardless what any back test shows. We believe that over 90% of Algorithmic traders are not monitoring the changes of market conditions and after the first losses appear they simply return to their manual trading where the usual human errors occur.
So do back test mean nothing at all?
No, a back test will show over a long period of time if the trading rules are solid. For example, if the percentage of winners is 56% over a period of 5 years, it means that the entry rule is good since the chance it will go back to 20% is very unlikely. The Drawdown is the most important indicator to check. So if you start using a strategy with a historical highest draw down of 20%, take into account that the drawdown you are facing could be 40% or more. The best way how to prevent yourself from having unpleasant surprises is to run an EA on a live account using defensive settings and to start with a low amount.
In case you have any questions about automated trading feel free to contact us.