Testing Backtesting: Why it doesn’t work

Guest post by forextraders.com.

In forex trading online, as well as in any other branch of trading where technical analysis plays a significant role, backtesting does not work. It is not suited to the the task assigned to it, and when does predict an outcome, there is no relationship between the assumption and the conclusion.

1. Price action doesn’t replicate itself over time

First of all, market prices are chaotic, and. The patterns observed on any day’s trading do not replicate themselves at other times. As a result, the attempt at testing today’s market action on the basis of yesterday’s patterns will never lead to results that can be duplicated over the long term.

2. There’s no perfect strategy

We can restate the above phrase by simply emphasizing the impossibility of creating a perfect strategy. At least with the tools possessed by traders in today’s world, it is not possible to create a fores strategy that will do well under all circumstances. The market action is chaotic, and it can’t be formulated by the simplistic methods of technical analysis. The forex market changes its rules every single moment; nobody can trade it with a strategy backtested over the past decades.

3. Backtesting inspires false confidence

Backtesting will give false positives, and emphasize some approaches over the others. You’ll feel confident that this or that strategy has the potential for yielding better results, and you’ll probably choose to increase your risk. Unfortunately, such an approach will only result in great disappointments and failures for the trader; you should never base your plans on backtesting.

4. Money management is paramount

Ultimately, one can succeed in forex not through the constant application of a few well-developed forex strategies supported and justified by backtesting, but through the most diligent and patient application of money management rules under all kinds of circumstances without any assumptions about the validity of a particular technical approach. Technical tools can always fail without any apprarent reason, because price action has a great degree of randomness inherent in it. Yet if you take risks with prudence, you can limit your losses.

Baktesting a strategy will not give you reliable results in your quest to find a perfect forex trading strategy, but it does have some vale as an educational tool where you can evaluateyour understanding and knowledge of analysis by backtesting your scenarios to see if you use the tools available to you in the correct manner. But keep in mind that backtesting is useless otherwise, and don’t jeopardize your trading by making assumptions to the contrary, regardless of the stridency of a forex broker’s, or a software peddler’s arguments.