MANUAL BACKTESTING OR FORWARD TESTING:
It is exactly as it sounds you are going to have to do the hardwork of staring at the charts and doing the evaluation.
1. Find a strategy or just create a random one.
2. create a selection criteria, or a grading criteria( if so and so happens). I will place a trade.
3. create the entry and exit criteria.
4. Calculate the return on the risk taken. over a period of the test period.
5. Tweak the strategy to maximize the reward and minimize the risk. Or create alternate entry and exit methods if you feel the criteria can be refined.
Example:
Say i wanna manually back test the hit rate of bullish engulfing pattern or pin bar pattern. These are the most common patterns in price action. I will pull up an old chart in a free demo mt4 account or if you have a paid trading view subscription and scroll back the chart and find my patterns and apply the above.
The strategy:
Find the bullish engulfing/bearish engulfing patterns on the weekly chart and see how they did.
Selection:
I will only trade the bullish or bearish or pin bar patterns of the major weekly S/R.
Entry and Exit:
I will enter when the price breaks below the pattern when it is a bearish engulfing and when it break above when its the a bullish engulfing. Or trade the break of the pin bar.
I will exit at the next weekly support and resistance area when the trade works or when my stop loss behind my trigger bar is hit.
See attached weekly chart to see the support resistance areas marked.
See attached weekly chart showing the setups that qualified as exact text book patterns.
Trade1:
195:382
Trade2:
108:404
Trade3:
217:370
Trade4:
469:248
Trade5:
198:273
Trade6:
198:336
Observations:
It will be noticeable from this very small sample size back test that the R:R is not that great but back test shows the most ideal setups had a higher win rate of 100%. In real world the traders patience is going to decide if they end up with a higher win rate or a much lower one.
It takes immense patience to wait for the ideal setup and in 2.5 years there were only 6 trades that were based on this very strict criteria.An impatient trader might take setups that dont fit the criteria and that could lead to poor results.
Dangers of back test:
You will have a tendency to cherry pick the setup, because you are looking at a chart that has already formed and you can already see the results.
Tweaking:
You could be a little bit lenient with entry criteria of candle stick and get more setups.You could zoom down to the daily chart and get more entries or reduce the risk by entering in the smaller timeframe. I wont get into the intricacies of that but essentially tweaking is changing the criterias for entry and exit or parameters to achieve better results.
Forward Testing:
Just wait for the setup to form again in the future and trade it.
Real world limitations:
In trading world an average FX trader will enter and destroy their career in less then 5 years, how could they ever find out if they were successful with the above strategy. Answer is they wont be able to because the number of setup that have formed are way too low. But that doesn't mean the setup did not work.
Another limitation is the account size, to make a meaningful return you would have to place a sizable position to make any meaningful sum. A mini lot returned 2013 USD and standard lot returned 20130 USD and 10 standard returned 201300 USD in 2.5 years. Would a small trader have that level of patience to trade this strategy and even the capital to trade this strategy to make a meaningful return in their lives.
I know 3 traders that taught this weekly trading method and had a great career and a good job and a good retirement sum they are just trading weekly charts to manage their money. So this work for them. But will it work for you. I don't know. They are managing their own money they are happy with the return and it work for them.
Another thought is that most traders do system hopping and wont follow a system over a large sequence or a longer period of time and will never have the results obtained from the back test. So the traders psyche decides their trading system and trading style. So a busy trader that has a full time job will find they are happy trading the weekly chart but a new young trader will feel that the opportunity set is limited.
Another thought is capitalization, you must read my previous framework post to know that the trader must have goals so they can achieve them. Clearly this above strategy can't benefit a trader that want to retire early in the UK if the account size they started with is 10000 USD and they were trading a mini lot.
This post sheds light on back testing and its intricacies. This strategy is a random price action pattern traded on a very large time frame and it doesn't represent all the strategies out there that you could trade. But i hope the basic clarity on manual back testing has been clarified.
