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!

---

Forex Market Overview

"FX" is an abbreviation of "forex" or "foreign exchange." Foreign... Read More

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... Read More

The Secret of Reduced Margin Spreads

One of the best kept secrets in trading is that... Read More

Online Forex

Q1: When you consider that the foreign exchange market has... Read More

Forex Trading Can Be Like Day-trading

Forex trading, or foreign currency trading, has become a bit... Read More

What are Your Options Regarding Forex Options Brokers?

Forex option brokers can generally be divided into two separate... Read More

Facts of Day Trading

Are you thinking of entering the fast-paced world of day... Read More

Discovering Turnaround Candidates

There are many types of investment methodology out there. All... Read More

The Miracle of Forex

My father, who owns a small parts store and garage... Read More

A Beginner?s Guide to FOREX

FOREX is the abbreviation for the Foreign Exchange market. FOREX... Read More

Forex Scams: How to Spot Them A Mile Away

In recent years, investors have witnessed increased number of investment... Read More

ISO 4217 in Forex Trading

ISO 4217 is an international standard describing three letter codes... Read More

How Do Other Countries Devalue Their Currencies?

Countries devalue their currencies only when they have no other... Read More

The Major Players in the Foreign Currency Exchange Market - FOREX

Since the US dollar is the centerpiece of the market,... Read More

The Meaning of FOREX Price Charts and How to Use Them

There is one very important factor that you should consider... Read More

Trade Entry Techniques

Most traders tend to concentrate on pinpointing the perfect entry... Read More

Hedging Foreign Exchange Risks

The exchange rate of the Macedonian Denar against the major... Read More

Is The U.S. Dollar About To Reverse Course?

For the first time in several years the U.S. dollar... Read More

Forex Currency Trading

It is possible to buy and sell money from different... Read More

How to Trade Currency

We all know when you go on a trip to... Read More

Dont Deny Reality

If you want to be a successful trader, you must... Read More

How To Handle A String Of Losses

Everybody hates to lose and unfortunately no one is blessed... Read More

6 Critical Factors For Successful Trading

Success in any profession can be broken down into a... Read More

An Evaluation of the Devaluation

A Minister of Finance is morally right to lie about... Read More

Disgruntled

The following situation happens quite often to many traders. Look... Read More