Backtesting your Forex trading strategies is great, but it is only half of the story. If you haven't read our Forex backtesting guide for manual backtesting, then do that before you move on with this guide.
You need to know how your trading system would have performed in the past, before you test it in the present.
But once you have a system that is profitable in backtesting, it's time to move on to forward testing. In this post, I'll show you why you need to do it, how to do it effectively and what to watch out for.
Alright, let's get those forward testing gears turning…
Table of Contents
In this post, I will give you a step-by-step process for setting up your first forward test. I will also answer common questions that traders have about Forex forward testing. Click on a link to skip to the section you need, or if you are a beginner, start from the top.
- Step 1: Understand Why You Need Forward Testing
- Step 2: What You Need Before You Test
- Step 3: Setup a Demo or Live Account
- Step 4: Track Your Results
- Step 5: Start Trading
- Step 6: Review Your Results and Look For Improvements
- Final Thoughts on Forex Forward Testing
- Frequently Asked Questions:
Step 1: Understand Why You Need Forward Testing
Backtesting is great, but you need forward testing too.
You see, there are things in backtesting that cannot be predicted in live trading conditions. These are things like:
- You might be sleeping when most good setups happen
- There might be differences between your backtesting charts and your live charts
- The spread and swap might be different enough that it impacts your profitability
- You might trade differently when real money is on the line
So for all these reasons (and a few more that I missed), you need to test your trading system in as close to real trading conditions as possible.
Step 2: What You Need Before You Test
You cannot just jump into forward testing directly. There are three very important things that you need first.
- The first thing that you need is a rule-based trading method. If you don't have one, then here are some courses that I recommend.
- Next, you need to have tested that system on the currency pair and timeframe that you want to trade it on. For example, if you want to trade it on the EURUSD daily chart, then be sure that you have backtested it at least three times.
- If the backtest was profitable over the entire backtesting period and you were happy with the results, then you are ready for forward testing.
Do not proceed until you have these three things. Once you have them, it's time to move on to step 3.
Step 3: Setup a Demo or Live Account
Now it's time for the big decision, live account or demo?
Most people will go for a live account.
But is that the right thing to do?
I say…yes and no.
You see, most responsible trading educators will tell you to start with a demo account because it is the CYA (cover your ass) thing to say.
…and they really might think that it is beneficial. They are entitled to that opinion, I'm not saying that they are wrong, because some traders will do just fine with a demo account.
But I would generally disagree with staring with a demo account. I think you are better off starting with a really small live account.
Here's why…
Trading is all about psychology. It's not about the system (contrary to what you may think right now).
…and the psychology of a real account (even a very small one) is much, much different from the psychology of a demo account. If you haven't experienced this yet, you would be surprised how different they are.
Even if you only have $1 on the line, it is a huge psychological difference, compared to having $0 on the line.
So, for most people, I would recommend setting up a live account with no more than $100 at a broker that allows you to trade nano lots, like Oanda.
The reason is:
Even with a tiny account like this, you can still take the proper risk, while still getting the feeling of risking real money. I would recommend starting off with 0.25% risk on each trade.
The only time that I would recommend starting with a demo account is if $100 is a significant amount of money for you, or if you cannot get access to a broker that allows you to trade nano lots.
Remember, you are not trading to make money right now. Because you probably won't.
The goal of this is to not lose a lot of money, while you are learning to trade your system well.
Step 4: Track Your Results
Now that you have decided on a demo or live account, it is time to track your results. You could use a spreadsheet, but there are better solutions, so you should use them.
The more time you spend messing with a manual spreadsheet, means less time spent on testing and analyzing your trades.
Just use an automated tracking system like MyFxBook to track your trades. It's easy and free, so there is no reason that you shouldn't use it.
That said, remember that you should also journal your trades.
You can use an online journal, a manual notebook or even a video journal. Find out what works best for you and use that.
Remember, the imperfect journal you actually use is better than the perfect journal you don't use. So just get started with the easiest thing and don't overthink it.
Step 5: Start Trading
Once you have everything setup, this is where the rubber meets the road.
Trade your system and follow the rules, just like you did in backtesting.
Not much more to it than that.
I would say to do about 100 trades in forward testing, before you start to change things. But you can adjust that number as you see fit.
If you are trading on longer timeframes, that might not be realistic. So use your judgement as to when to stop testing an reviewing your results.
When in doubt, test more than you think is necessary.
Step 6: Review Your Results and Look For Improvements
Once you have about 100 trades, it is time look at your results in MyFxBook and see if that match your backtesting results. Obviously, they won't match exactly.
But if the results are way off, then you have to figure out what is wrong.
Here are some possible reasons that your results could be different:
- You are not available during the times that your best trades setup
- You only backtested during a period when your system worked really well
- You didn't backtest over a long enough period of time
- Something in current market conditions has changed
- You aren't following the same rules in forward testing, that you used in backtesting
- You are using a different amount of risk
- You could be in a normal drawdown in forward testing, making the results look really bad, but is otherwise normal
These are not the only reasons, but you get the idea. It's up to you to examine the results and figure out if they are valid or not.
Final Thoughts on Forex Forward Testing
That is how you get started in Forex forward testing. It is a vital step in the trading process, so don't skip it.
Most beginning traders will put all of their risk capital into a live account and trade it with no system.
…and that is why most people blow out their accounts within the first few months.
Be different and give yourself the best shot at success.
Frequently Asked Questions
Do I Really Need to Forward Test?
Short answer: Yes.
Long answer:
- Would you ride a motorcycle on the freeway without being able to drive in the parking lot first?
- Would you skydive solo, on your first jump…with no instructions?
- Would you do brain surgery on your mom, before going to medical school?
- Would you go shark diving without a cage?
You get the point.
Forward testing means trading in real market conditions.
You need to walk before you can run.
Should I Forward Test in a Demo or Live Account?
You will hear different opinions on this. The safe answer is to tell you to get started in a demo account, so you don't lose any money.
But this isn't always the most beneficial way to do it.
When you trade in a demo account, the trading psychology is very different between a live and a demo account. You will be surprised how much you will stress a trade, when there is as little as $1 at risk.
If you trade in a demo account, you might find that you also lose interest quickly.
I do.
I believe that you will learn much faster and stay engaged in the process if you trade in a very small live account and use nano lots.
Therefore, I recommend opening a $100 account at a broker like Oanda and risking only 1% per trade, or less.
Your goal is not to make money. The goal of this exercise is to learn how to trade well.
Make sure you hear me, because a lot of people put all of their money at risk from the start.
Start with a very small account. If you cannot do this, then you don't trade at all because you will lose all your money!
Can I Skip Backtesting and Go Straight to Forward Testing?
Yes you can. But it will take longer.
Much longer.
Backtesting gives you a good idea of if a trading strategy will work or not. Once you have a system that would have worked well in the past, it is time to test it in current market conditions.
Without any knowledge of historical performance, you are walking through the testing process. Backtesting puts you in a Porsche.
I'm sure you understand this intellectually, but this video will drive the point home.
How Long Should I Forward Test?
This really depends on your trading system and your personality.
If you are trading a longer timeframe system, you will probably have forward test for a longer period of time because you will have fewer trades.
But if you really need a rule of thumb, I would say to trade for at least 100 trades. Even then, you have to be super comfortable with the system. If you aren't, then keep forward testing.
My friend Walter Peters says that you should be able to triple your demo account before you ever trade real money.
But only you can determine when it is time for you to trade will your entire risk capital.
Still Have Questions About This Forex Forward Testing Guide?
Leave a comment below and let us know if you still have questions about the process…
