Back testing your Trading: The Skeptic’s Triumph

Back testing is popular, but it is not very reliable. There are many reasons that make it ineffective, and misleading as a testing tool, but none of this matters much because it is essentially a marketing tool developed for and by forex system creators. And why doesn’t work? Read on for further discussion.

Let’s first make it clear that back testing is useful only with auto-trading. With manual trading, it is rather hard to follow a strategy with the degree of faithfulness one would be achieving in a back testing environment. So use back testing only if you auto-trade, and don’t bother if you’re primarily a hands-on trader who micromanages his positions.

But we don’t mean that back testing is useful with auto-trading. Quite the contrary, it still has no value because the market creates new mathematical rules and patterns without warning throughout the trading day. In a way very similar to the chaotic nature of a series of earthquakes, market participants will take decisions that are almost impossible to predict with precision beforehand. Many tools allow success in hindsight, but the picture is very different when the patterns are still developing. In short, the task aimed at by back testing is pointless. A forex strategy can only achieve consistency through successful and diligent money management methods, otherwise there will be enough so-called black swan events to bankrupt anyone who relies on back testing too much.

Another point is that the market action does not repeat itself over the longer term in a way that lends itself easily to mathematical analysis. We do not know how to order the chaotic jumble of information to create a deterministic, easily formulated strategy that will allow consistent profits. This fundamental deficiency cannot be addressed by back testing.

In short, back testing has no logical foundations. It is built on whim and fancy and cannot generate any of the results expected from it by the enthusiastic trader.

Depend on money management for improving your results. Forex strategies try to control or guess the market action, which is unpredictable, and over which you have no power. Control yourself instead with money management methods, and you will observe a perceptible improvement in no time.

Forex trading software sometimes come equipped with back testing tools; you should ignore them. You can use them at most for testing your ideas to get a very vague idea on whether they function in the way that was intended, (i.e. did you interpret each indicator correctly?) But back testing has absolutely no value as a measure of a trading strategy’s potential. Test your methods by trading them. Don’t waste your time with back testing.

Bryan Sayers
ForexFraud.com