Forex Blog: Currency Trading News & Analysis.

March 10th 2009

How to Develop and Backtest a Profitable Forex Trading Strategy

The holy grail of forex is a trading system that can turn a consistent profit, irrespective of the currencies involved and prevailing market conditions. While this has been promoted disingenuously by many a forex broker and forex software provider, suffice it to say that it remains elusive. A more realistic goal would be to build a strategy that is profitable most of the time (i.e. wins more than it loses). I don’t pretend to have developed such a strategy; instead, I would like to outline a method that can be used to confirm (or deny) whether your strategies are strong enough to withstand the daily whims of the forex markets: backtesting.

Simply put, backtesting involves applying a trading strategy to historical data. In other words, by checking the parameters that normally guide your trading against the way markets actually performed in the past, you can easily determine the stipulations/conditions that will make such parameters robust. Parameters include time period (hours, days, weeks, etc.), expected profit per trade (percentage, or number of pips), cumulative profit goal (i.e. 25% annual return) currency pair (USD/EUR, EUR/YEN, etc.) and comfort with risk (i.e. stop/loss). Stipulations, on the other hand, can be as simple or as complicated as you would like. For example, let’s say you want to buy whenever the currency pair breaches its 15-day moving average, and/or sell when the stochastic falls below a certain threshold. These kinds of stipulations can also be qualitative; let’s say, for example, you sell the Euro every time the European Central Bank lowers interest rates, or buy the Dollar every time the consumer confidence index records a rise.

The most robust strategies are profitable under a variety of market conditions, when profit goals are flexible. (For example, try adding or subtracting 5 pips to your expected profit per trade, and see if your strategy is still profitable). It is also important to remember that some strategies don’t lend themselves well to backtesting. Trendlines and other technical ‘patterns,’  for example, are often too circumstantial to be applied and tested generally. Backtesting also doesn’t account for market psyschology. While it would be nice to devise a strategy that is profitable in a variety of conditions, sometimes it must be condeded that when market sentiment is especially (and often irrationally) bullish or bearish, one’s strategy may not apply.

Having developed the paramaters and stipulations, how can you backtest your strategy? The pioneers (and perhaps even some stalwarts today) manually parsed reams of data, going through daily and weekly charts to determine the sets of conditions, if any, their strategies were viable. With the use of powerful computers, this tedious process can be completed automatically. If you’re not up for building/coding a system yourself, don’t despair, as there are a handful of great programs that have been professionally designed for amateurs to use.

Here, you have two main options. You can open a (demo) account with any of the forex brokers that incorporate backtesting software into their trading platforms. Pay special attention to those that use MetaTrader4 (MT4) – of which there are several reputable brokers– because it is the most critically-acclaimed and user-friendly. For those of you who don’t have access to such software, several downloadable versions can be found here, and a quick google search turned up a list of commercial software. Sometimes, such software requires you to provide your own historical data, which can be found here.

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Posted by Adam Kritzer | in Investing & Trading | 2 Comments »

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2 Comments of “How to Develop and Backtest a Profitable Forex Trading Strategy”

  1. FxV Says:

    You can also get historical data from or you can download it in the history center of MetaTrader4.

  2. Hugh Kimura Says:

    These are some good options for automated systems testing, but what backtesting software do you suggest for discretionary traders?

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