Limitations of Demo and Backtests
Advantages for Performing Demo and Back-testing Evaluation
1. History repeats itself. Repeated patterns can be identified from the back-test.
2. Investors can be educated with key ratios like max draw-down so that they know what to expect when using the systems.
3. Increases investors’ confidence to rely on the systems during the draw-down period. Thus, investors know when to stick to the trading rules and when to discard the trading system.
4. Provides an estimate of the probability and magnitude of the potential trade profits and losses because the performance statistics can be reproduced by back-testing.
Limitations of Demo Testing and Back-testing
1. Spreads
Liquidity conditions during certain news hour may narrow the spreads. GMT day spread and night spread may differ due to liquidity conditions. All of this widening and narrowing of spreads may not be accurately accounted for in the bid and ask price.
Strategy that requires certain max spread conditions would not have perform as well in live trading compared to a back-test.
Metatrader trading platform assumes the spreads conditions are constant at the time when back tests are generated. This is a limitation of the trading platform. Unfortunately, spreads will never be constant in live conditions.
2. GMT OffSet
The server time may change at certain time of the year in UK and US due to summer and winter daylight saving hour. The price and history feeds may not correspond to the specified chart timing. This will mean that certain strategies that only trade at certain hours may get prices mismatch figures.
3. Brokers’ Manipulation
Certain brokers’ will offer close to ideal trading conditions in the back-test and demo test. This ideal conditions certainly do not happen when trading live. The idea doing this is to attract as many potential traders to use their services. You can find out more information on some of the popular forex forums online.
4. Trade Entry Method
Systems that use market order for entries may face difficulty in getting in at the right price you want in the live conditions. The fact is during live conditions, the market price will be very volatile and getting in at the right price manually will be a problem. There will be a difference in the entry prices between back-test or demo with live conditions.
Summary
Having to recognise the limitations of backtests and demo test, it will help us in understanding more about how the trading systems work and how to evaluate and analyse a system better. It does not mean that backtest results do not work, the fact is, it still works. At FxEAReview, we believe in education so that you can identify the best profitable system out there.
Warren Seah
Feel free to use this article on your website or ezine as long as the following information about author/website is included.
Warren examines commercial trading systems and has since started researching and analysing systems to uncover good systems which bring in consistent profits. By publishing all the research papers and detailed analysis online, he seeks to educate potential investors and traders on the world of trading the forex market with automated systems.
To read more about these research papers and analysis, go to
Read Related Articles
Reviewing Systems with Important Ratios
12 Backtest Evaluation Indicators Before You Hit the Buy
4 Backtest Limitations any Investors Must Know Before Purchasing a System
We feel that this subject is very important and should be explained in greater detail. By getting yourself educated on how our reviews are rated at FXEaReview, you will be able to utilise the information and personalise it for your own trading.
Trading Systems are rated based on (in order of priority) :
1. Money Management
Can the system allows you to specify the amount you risk per trade?
This is the most important factor in trading because it prevents you from having unexpected losses. In our search for a trading system, we will find systems that trade with a stop loss level. This will allow us to know how much percentage of our account equity is at risk in a single trade.
For beginning traders/investors, we strongly advised that you trade with a maximum 2% risk per trade and a max 10% risk per month.
If you manage your risk, the profits will come.
Beginning traders have a low ability to take losses and it will take a process to find out your personal risk tolerance.
If losses incurred are more than one can handle, it may lead to revenge trading and overtrading. These will devastate your account equity or make you lose your shirt!
2. Draw-down
What is the risk to reward ratio? What is the maximum draw-down over a specified period of time? How does using a specific risk per trade affects your max draw-down? What is the maximum consecutive losing trades in a row over a specified period of time? What is the winning percentage and average win versus average loss? How many winning trades and how long to recover 1 losing trade?
We need to expect and be prepared the maximum loss in percentage the system can make over a specified period of time. This can be deduced from generating back test.
Having this piece of information will allow us to know whether the system is still trading within it rules or the market has changed and rendered the system ineffective for current situation.
3. Ease of Use
Is the rules of the system provided clear and easily applicable? If it is an automated trading system, are the parameters easily understood and optimised for personalised results?
4. Honest Result
Do the forward test results resemble back test results closely? Does it perform according to what the salespage has stated?
This is quite subjective and we leave it to you to compare the forward and back test results.Key ratios and indicators will be highlighted to help your analysis.
5. Other Features
6. Weaknesses (If Any)
We need to understand the weaknesses of the trading strategy so that we can expect how it will perform during specified market conditions.
7. Support
Is the support contactable? (If no comment are made about the support, assumed that support is working fine) Are there frequent software updates by the owners Is there a forum?
8. Profitability
What is the ROI over a specified period of time? Is the trading system worth the purchase price?
Summary
Rating
Overall, how the trading system fare? (Rating will be reviewed from time to time as trading strategies may change.)
Warren Seah
Feel free to use this article on your website or ezine as long as the following information about author/website is included.
Warren examines commercial trading systems and has since started researching and analysing systems to uncover good systems which bring in consistent profits. By publishing all the research papers and detailed analysis online, he seeks to educate potential investors and traders on the world of trading the forex market with automated systems.
Read Related Articles
Reviewing Systems with Important Ratios
12 Backtest Evaluation Indicators Before You Hit the Buy
4 Backtest Limitations any Investors Must Know Before Purchasing a System