Financial analysis is a very important step when it comes to either trading or any other kind of financial activity of the market. Due to the fact that we are using our capital and it might affect our financial situation, before actually trying it, people are using simulators.
To describe what it exactly means, it is a program or application that attempts to reproduce or duplicate some or all feathers of a live activity on either stocks, shares, etc. on a computer and the trader is having an opportunity to practice trading without its own financial risk. One of the most important parts of any trading process is creating your own trading plan and trading strategy, which guarantees the efficiency of the trading itself.
What is backtesting and how does it work?
Backtesting is an electronic process that allows traders to check the results online and test how their strategy works. As we have mentioned before, a trading strategy is one of the most important parts of the trading process and backtesting is very helpful for the traders to see the outcome roughly. Those who use backtesting in their forex trading are usually in a better situation but it does not mean that the trader should count only on the computer and technology and do not use its own knowledge and understanding of the market. Human logic is still important in this case.
It is vivid why someone would use backtesting because it is a good way to try what you have planned without risking your finances, however, there are several other reasons for that. Within the backtesting opportunity, you are able to have a strategic insight into the process. It means that the forex traders are able to determine whether their chosen strategy is going to have the same outcome they expect or not. Secondly, it gives the chance to practice by looking at past price movements and helps to develop technical analysis skills. Last but not least, traders can gain confidence, which matters a lot in the trading process as they have already experienced their strategy and are able to be more or less sure about the possible outcome.
The trading strategy is a set of price data and the traders are acting according to it. It helps to determine any unforeseen flaws in the current strategies. Due to the technological advancements, the process is very much simplified and the traders use different software to backtest Forex strategies and they can get a number of indicators, such as the total return of equity, total profit and loss, and the ratio of them. Most importantly, what traders are trying to determine is the volatility, where the strategy is used in terms of uptrends and downtrends.
Factors that have an influence on the outcome
There are several factors that are working on the outcome of backtesting strategies. The results can be altered by the following factors:
- Data quality and source – the accuracy of data is vital in the backtesting process. however, the trader should take into consideration that backtesting is not happening with the current data and can be different from the exact time of the trading process.
- Determinism – the backtesting strategies most likely should be 100 % (how unrealistic it may sound) deterministic. For the defined data, you should receive the exact same result, no matter how many times you have tried them.
- The logic of trade execution – one thing to keep in mind is that backtesting is never a realistic and perfect representation of the actual market. However, the outcome should be corresponding to the logic, and slippage, rejections, or many other factors, cannot be taken into account.
Finally, to summarize, trading is a very complex process that needs specific knowledge and many aspects to be taken into consideration. Because of the many details and financial risks, traders are given the opportunity to try the process without risking their actual finances and most importantly try out the trading strategy which is the backbone of the trading process. Technological advancements have made it possible to make the testing process more efficient by using special software for it and gives you a rough picture of what the probable outcome of real-time trading would look like.