TOWER ONE FX GROUP

In the previous step in your FOREX Trading Education we created a system based on observation over a short period of time. Now, it is time to Backtest and Validate it in order to really know if it holds up. In other words we need to go through a significant amount of historic data, write down every signal and evaluate them. On every signal you have to write down the following:

• Entry price
• Predetermined Profit Target or Exit Price according to indicator
• Minimum Stop-loss amount that would have kept you in the trade

You need at minimum of 30 trades (round-turns) for this exercise to be statistically valid. To be on the safe side, it is advisable to register 50 – 100 trades. Since all trades are not profitable, the losing trades will be marked as such. Later the losing trades will be marked with the optimal Stop-Loss amount so that we can calculate the profitability of the system.

I have prepared design for you please send your request to my email. The reason we are exerting all this effort is of course to determine if the system is profitable and to what extent. But it also has further implications. When you have developed a system, backtested and validated it you also trust it. If you trust it you feel confident trading it, confident that you can live your dream. This is extremely important. If bad Trade Management doesn't sink your ship, bad psychology will. If you are not confident in your newly constructed Trading System, how will you be able to trade it profitably? Low confidence will actually put you in a situation where you will make unforced errors, contributing to bad system performance and even lower confidence. Don't hold back on your Forex Trading Education!

One very important point to consider when backtesting by hand is ambiguity. When a human is backtesting he (or she) might unknowingly “improve” the profitability of the system. Be very careful not to fall in this trap. Be exact and add a little slippage (a couple of pips will do fine) to your entry and/or exit in order to simulate real trading conditions. Remember that entry and exit is made on the bar after the signal was triggered.

Now we need to validate our trading system's tradeability. You have filled in the Backtest Log with the data from your backtest and with that data at hand we will determine how good it actually is.Calculate the following measurements:

• Profit Factor
• Percent Winners
• Max Drawdown
• Max Drawdown as percent of initial capital
• Average $ Profit
• Average $ Loss
• Max consecutive Winners
• Max consecutive Losers

Compare your own values to the optimal. Please understand that it is usually very difficult to fulfill all. Personally I put emphasis on Profit Factor and Max Drawdown as percent of initial capital. I also keep an eye on Max Consecutive Losers, because a high number here can be difficult to manage psychologically. We are all different and I don't want to tell you what kind of system to trade. As long as you like it, feel comfortable trading it and it is fairly profitable, then go ahead.

When you filled in the Backtest Log, you also wrote down the minimal Stop-Loss amount that could have kept you in the trade. Now you need to check different levels of the Stop-Loss in order to optimize this. You also need to take into account the amount of risk you can afford. The wider your Stop-Loss the more winning trades you will have, but at the same time expose yourself to more risk (and drawdown). A narrow Stop-Loss have the effect of asphyxiating your trades leading to less winning trades but also lower risk. You need to find a working balance where you let your Trading System free to profit but at the same time controls risk. A fine balance indeed.

Don't stop trying. Get your Forex Trading Education Right!. Follow the Course!


Tip: Scaling is a much looked over subject that most traders should take a deep and long look at. Scaling can actually take a losing Trading System and turn it into a winning, however this is very dangerous practice. But think again about the implications of this fact, intriguing isn't it?. So what is Scaling? Scaling is simply a set of rules determining when and how much you should add to or subtract from your position. You can scale in or scale out. Scaling in means you are adding (entering new) contracts to your position, for example you start with one contract and when price has reached a certain level you add (enter) another, additional contract. Scaling out means you are subtracting (exiting old) contracts to your position, for example you start out with 4 contracts and at predetermined price levels you subtract (exit) two at a time. Try out both methods and choose the one that suits your trading style the best, or use both after you have master one of them. Note: Never, ever add to a losing position.


Action Step: In the previous Action Step you constructed your own Trading System. In this Action Step we will take a closer look at what you did. Answer the following questions:

• Do you have 4 or less indicators on the chart?
• Do you use indicators which are not overlapping each other in terms of function?
• Do you use 4 or less rules for each Entry and Exit Set-up respectively?

If you answered yes on these three questions you have fulfilled at least the basic rules of Trading System development. Keep on going in your Forex Trading Course!!

Go to the next part, Step 5.