The Importance of Backtesting A New Strategy
Most traders have some sort of trading strategy. But they still don't get the results they're looking for. Why?
Often, this is because they are too focused on making money now. They overlook an important step in the trading journey: backtesting.
Wouldn't it be nice to know whether your strategy is fundamentally sound enough for the live market? That way, if it isn't, you have the chance to change what doesn't work, or discard the entire strategy in favour of one that works.
In this article, we’ll look at the importance of backtesting and how it can help traders succeed. But first, let’s find out what backtesting means.
What is Backtesting?
Backtesting is applying your trading rules to historical market price data. You can then use the data from your backtest to range your system viability (how good it is).
Chances are, if it yields positive results on the past market data, there is a good probability it will give you either the same or slightly different results when you trade it in the live market.
Why is Backtesting Important?
There are many reasons to backtest any new strategy, but here are the most important ones:
1. Answer if Your Strategy is Profitable
Backtesting provides a clear answer to the most important question for any trader: "Is my strategy profitable?"
Without backtesting, you are technically flying blind, unsure whether your system works or if your risk management rules will win. By testing historical data, you can simulate how your strategy would have performed, giving you a clearer picture of its potential success before risking real money.
This prevents costly trial and error in live markets and helps you avoid strategies that might seem good in theory but fail in practice.
2. Build Confidence
One of the biggest benefits of backtesting, which is also one of the primary aspects of any trading journey is building confidence–confidence in your trading strategy and the positions you take.
You see, once you've tested your system and verified its profitability over a large number of trades, you gain the confidence to apply it in live markets. Seeing the bigger picture—such as having a higher number of winners than losers, or knowing the average size of your winning trades—helps you stay calm and stick to your system, even if you hit a losing streak.
Backtesting gives you a solid foundation to rely on, reassuring you that trading is about the big picture, not the outcome of a single trade.
3. Build Experience
Backtesting accelerates your learning curve by exposing you to a large amount of market data in a short time.
Yes, the live market experience is invaluable, but it can take a year to observe a year’s worth of data.
Backtesting allows you to condense this experience into days or weeks. It helps you develop an eye for how the market moves and recognise patterns that might take much longer to develop if you were trading in real-time.
And even though it doesn't involve real money or the emotions of live trading, it still provides an extensive understanding of market dynamics, which is essential for becoming a successful trader.
4. Speed Up Your Trading Journey
Backtesting speeds up your trading journey by allowing you to test and refine your strategies much faster than live trading.
As mentioned, instead of waiting for the market to unfold day by day, you can simulate months or years of trading in a fraction of the time. You can then have the results condensed in a trading journal, which you can analyse to identify patterns and profitability. This enables you to adjust and improve your strategy more quickly.
Moreover, optimising your system through backtesting helps you avoid the slow and often costly trial-and-error process of live trading, bringing you closer to consistent profitability.
5. Identify Weaknesses and Improve
Backtesting is not just about validating whether a strategy works; it’s also about finding where it doesn’t. Through this process, you’ll be able to identify the conditions in which your strategy underperforms, whether during volatile markets or particular price patterns.
You can use this insight to refine and tweak your approach, improving your strategy and potentially turning weak points into strengths.
This learning process makes you a better, more adaptable trader.
How to Backtest on MetaTrader 5 (MT5)
MetaTrader 5 (MT5), the platform we use at Optimal Traders, offers a built-in backtesting tool called the Strategy Tester. This tool allows traders to evaluate automated trading programs, known as Expert Advisors (EAs), using historical market data.
Here's a simple guide on how to backtest using MetaTrader:
- Select and Load the Expert Advisor you want to test to install on the platform.
- Open the Strategy Tester Tool from the 'View' tab.
- Set Parameters such as the data range, the financial instrument, and the timeframe. Adjust these based on the market conditions you want to test the strategy.
- Run the backtest. MetaTrader will simulate trades based on your EA and chosen historical data.
- Analyse the Strategy Tester reports including profit/loss ratios, the number of winning/losing trades, and risk factors.
- You can rerun your backtest by adjusting parameters like stop-loss and take-profit levels.
Note: Although MetaTrader is a powerful backtesting tool, it's designed for automated EAs.
If your strategy needs testing manually, you can use backtesting software like TradingView or Forex Tester.
At Optimal, we have a 1-step algo account that allows EAs Algos and trading bots, giving traders the power to trade how they want.
The Bottom Line
No trader has ever become worse off from backtesting. Backtesting can only improve your knowledge, trading ability, and results.
If your strategy proves profitable, you gain the confidence to execute it in live markets. If not, you have a golden opportunity to adjust and optimise it for better results.
Beyond that, you sharpen your ability to recognise price patterns and identify key market trends, giving you a real edge in your trading journey.
Once you're confident in your strategy, Optimal Traders can provide the capital to take you to the next level. As a trusted prop firm, we offer traders the resources they need to accelerate their trading careers without risking their funds.
For more information check out our challenges or visit our FAQs to get answers to your most pressing questions. Our customer support team is available 24/7 via live chat, email, or Discord to assist you.
Backtesting FAQs
How often should I backtest my trading strategy?
You should backtest your strategy when you’re starting or whenever you make major changes or adjustments. Regular backtesting can also help identify when your system may need to be revised or improved.
How many trades are enough for backtesting?
There's no straight answer to this question. A general rule of thumb is to test as much data as possible. The larger the sample size the better the statistical significance.
What are the best platforms to backtest?
Several platforms are highly regarded for backtesting:
- MetaTrader: Popular for automated trading strategies (Expert Advisors).
- TradingView: Known for its user-friendly interface, TradingView allows for strategy creation and backtesting using Pine Script, making it suitable for traders in various markets.
- Forex Tester: This platform provides advanced backtesting features, including market replay and optimisation capabilities, making it ideal for day and futures traders.
