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!
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