Back testing versus Forward Testing


AtoZ Markets – Back testing versus forward testing, what benefits are involved or is there any? Well if you would ask most traders, you would get different viewpoints. One thing is clear, if you have a trading idea (I will refer this as trading strategy from now), it needs to be tested. We will leave the detail mechanics of how to back test/ forward test and for this article keep things simple.

Why test a trading strategy?

The most common reasons among traders on why to test a trading strategy could be summarized as the following:

- Get confidence that it will be profitable , after all you are in trading to make money

- Under what market conditions will the trading strategy perform, no good trading a strategy whose performance in a ranging market is poor compared to when it is in a trending market.

- Getting familiar with the trading strategy initially on different forex broker's trading platforms.

What is back testing?

Back testing is when we test a trading strategy to a defined set of historical data for the sole purpose to find out the performance of the trading strategy. You use this set of data to “tweak/optimise” the trading strategy. You then back test the trading strategy on a set of historical data which has previously been “untested”.

Pros

1. Trading psychology: Gain confidence in the trading strategy

2. Get familiar with the trading strategy and in necessary improve the trading strategy.

3. Testing your EA or indicator

Con’s

1. You cannot take care of all the market conditions, especially fundamental developments

2. Dealing with different forex brokers slippage

3. While testing strategies, your take profit might be triggered at the top a candle or the stop loss is not triggered, in reality this may not be the case

4. Over optimisation of the trading strategy

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Forward testing

Forward testing is when we test the trading strategy in simulation of actual trading, in other words, you “paper trade” following the trading strategy conditions.

Pros

1. Gain confidence in the trading strategy

2. Get a good idea how the trading strategy is performing in the actual markets

Con’s

1. Dealing with play money

2. No emotion towards the result as the money being traded is not real and not yours!

3. EA performs well for a short time period only and have to re-program, never ending cycle.

See also: How to become a self-disciplined trader

Forward test in three stages to really find out the performance and robustness of the trading strategy

- Demo account

- Real account (microlot) (3-6 months)

- Real leveraged account (3-6 months)

Important: Aside the choice for back testing versus forward testing, both will not account for “latency”.

About the contributor

This article was written by TradingDoc.

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