Building a trading strategy is obviously not easy, but once you’ve tested your trading system you can then follow it on “autopilot” – the system makes the decisions, you’re just implementing them. This allows you to be more efficient in the long-term. Why test your trading plan? How do you test it and what by criteria should you be evaluating it?
Why You Should Always Test Your FOREX Strategy
To make profits consistently, it is not enough to find trading patterns on your charts. It’s more about utilising a trading system that will allow you to manage risk appropriately, control your emotions, etc.
Why do you need to test your trading plan
When you think about your trading plan and you’re building up your trading system, it is important to test it on the FOREX market to test its validity and performance. By testing it, you will have all the needed setups to have enough self-confidence to take risks when favourable trading opportunities arise.
It’s only by testing your trading plan that you will know if your strategy is worth following. Testing your trading strategies can help you know if it’s necessary to make adjustments to your parameters.
Testing your strategy also means scientifically analysing why you succeed or fail. This should help you understand which currency pairs are best to trade, what timeframes to use, which indicators and what market conditions allow you to achieve the best results (bullish, bearish or sideways consolidation) etc.
How to get started
When you start working on your trading plan, you might feel lost because of all the choices you have to face regarding your trading style, the indicators or timeframes you can use, the currency pair on which to focus, the money and risk management parameters to setup, etc.
To define your trading plan, try to think about the following:
- Choose how often you plan to trade:
swing trading, scalping or intraday trading, buy and hold…
- Choose the tool/indicator you want to use and study it:
moving averages, channels, support and resistances levels, Fibonacci retracements…
- Write down everything:
you will then be more disciplined about your trading plan, how you make your trading decisions and how you manage them.
- Commit to your choices and explore your trading strategy:
you will need to follow the rules you wrote down to test your trading plan in order to test your trading plan in the most accurate way.
How can you determine that your trading strategy will be profitable without testing your strategy? You can’t! It’s best to test your trading strategy on a demo-account or a real-account. The later will allow you to better manage your emotions, which play a significant factor in your overall trading performance. For more information, you should definitely read: DEMO ACCOUNT VS REAL ACCOUNT.
What to assess and monitor after you run the tests
You can assess the probability that your strategy will keep making profits from a statistical point of view by testing and iterating your strategy. This means sitting down for a few hours several times a week and putting in the work to run those tests, to observe market conditions, to grow your sample size, and to adjust what you don’t like about your strategy.
While testing your trading plan efficiency, you might want to have a look to the following criteria:
– Number of trades,
– Average Trade Length,
– Expected Payoff = Net Profit / Number of Trades,
– Profit Factor = Gross Profit / Gross Loss,
– % Positions Won,
– % Positions Lost,
– Relative Drawdown = peak-to-trough decline during a specific period of time,
– Recovery Factor = Net Profit / Max Drawdown.
You should develop your own preferences based on your risk tolerance, trading style and financial situation. Do not forget that nothing lasts forever, including Forex strategies. As time passes, market conditions will change and your strategies will need adjusting, even after they have been developed and are put to use. For more information about trading strategy deterioration, please read: FOREX STRATEGY DETERIORATION: YOU SHOULD BE MONITORING THESE STATISTICAL PARAMETERS!