When you don’t know what you’re backtesting or why, you might never reach your desired outcome. In this article, I’ll shed some light on backtesting in trading to help you find your way.
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1. Choosing the Right Currency Pair for Backtesting
I’ve seen many traders who believe that every strategy should be backtested, and that’s good. But often, they don’t understand which strategy to backtest on which currency pair.
We only have the freedom to choose a currency pair for trading as long as we haven’t selected our strategy. For instance, after picking a classic technical strategy, you can’t apply it to a 1-minute timeframe on gold—it simply won’t work for that asset due to its unique nature.
2. The Role of Timing in Trading: Myth or Reality?
There are countless trading courses out there that claim something special happens at a particular hour. But when you review these courses, you realize they all fall between the opening of the London session and the end of the U.S. session! This is a classic example of trading based on randomness. You can pick any time during this range, and in backtesting, you’ll find a significant event occurred.
I’ve spent a lot of time analyzing different strategies, trying to pinpoint a specific hour for success, and believe me, it might work for a month, but eventually, it will get crushed by the reality of fair distribution.
And whether you believe it or not, when I mention large data sets, I’m talking about around 20,000 different strategy variations, each with unique approaches (even a simple moving average crossover can be implemented in dozens of ways).
High-volume trading times directly affect the number of signals and the equal probability of profits or losses. Price movement is evenly distributed across different hours. So, stop chasing that “golden hour” for trading. Instead, adopt a broader view of trading sessions and select one for your backtesting.
3. The Latest Results Matter the Most in Backtesting
One of the best approaches to determining whether a strategy is profitable or not is to focus closely on your most recent backtesting results and what’s happening now.
What’s the point of trading a strategy that performed well in 2023 but is making losses in 2024, hoping it will return to its glory days? Of course, many factors come into play, but this is something crucial to consider.
4. The Hardest Part of Backtesting
When I tell traders they need to account for sentiment in their backtesting, many resist. And for just one reason! It’s hard for them to go through the trouble of gathering recent financial data for a currency pair and including it in their backtest.
The market doesn’t care about your strategy signals. No matter how loyal you are to your system, if there’s strong sentiment behind a currency pair, there’s a high chance your trading signals will consistently fail. That’s why you need to understand how different sentiments affect your strategy and adapt accordingly.
Conclusion:
There are other aspects to consider in backtesting, which I’ll cover in future articles. But for now, these four points are the most important:
– Choose the right currency pair and matching strategy.
– Take a broad approach to trading sessions, avoiding the idea of a “golden hour.”
– Pay close attention to your most recent backtesting results.
– Dive deep into the relationship between strategy and sentiment.
Related Topics :
What is backtesting and how do you backtest a trading strategy?
