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Category: Articles » Finance » Article » Article Code

Day Trading, Forex or Currencies Back Testing - A Way to Improve Your Trading Score

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You can draw some useful parallels between running a business and Day 
Trading, Forex or Currencies trading. For instance, most successful businesses 
keep statistics on everything from their conversion rate, to their average 
dollar sale, to the number of people that come in the door. Businesses do this 
to keep on top of how they are doing on a day to day basis and businesses must 
first take score before begining to improve on that score. Using a Day Trading, 
Forex or Currencies back testing plan in your trading works exactly the same 
way.
  Now that you're looking at Day Trading, Forex or Currencies trading 
as a business, you need to learn some valuable statistics about your system so 
you can improve it's performance. You would use a Day Trading, Forex or 
Currencies back testing method. You can't improve your system unless you have 
something to measure it against. How could you expect to improve your trading 
unless you knew what it was you were looking to improve? You can discover these 
measurements and other valuable information about your trading system, by using 
a Day Trading, Forex or Currencies back testing plan.
There are two ways that you can use a Day Trading, Forex or Currencies back 
testing plan to back test a system. You can do it manually, which can be a drawn 
out and labour intensive process, or you can do it with the aid of some software 
packages. Unfortunately, I recommend you do it by hand when you first start out. 
You'll get a much better feel for your system, and you'll understand exactly how 
using a Day Trading, Forex or Currencies back testing plan works in all its 
intricacies. Once you have the Day Trading, Forex or Currencies back testing 
plan and the in depth knowledge, you could look at finding a software package 
that does it for you. 
There are a few major statistics on your Day Trading, Forex or Currencies 
back testing plan that you need that you will uncover through back testing. The 
first statistic you need to become familiar with is the R multiple principal. R 
stands for risk, the risk you take on any trade when you enter the market. The R 
multiple of a trade is the ratio of the profit or loss compared to the amount of 
money risked to make the profit or loss. 
Therefore, if you risk $200 dollars in your initial purchase, and you make a 
profit of $1,000, you have made five times the amount you risked in the trade. 
You have an R multiple of five. This statistic gives you a good idea of the 
relative size of your profits to your losses. You can compare the average size 
of your winning trades with the average size of your losing trades.
The next statistic you'll find useful is your win to loss ratio. This is how 
many times you get a winning trade in proportion to how many times you get a 
losing trade. For example, if you had ten trades, four of those trades were 
winners, and six were losers, your win to loss ratio is simply four to six. This 
is your hit rate; you'll get 40% of your trades correct.
With these two simple statistics, you can calculate the average size of your 
profits and of your losses, multiply these figures with your win to loss ratio, 
and calculate on average how much money you make with every dollar you risk. 

For those of you who think this sounds like a too much work, particularly 
using a Day Trading, Forex or Currencies back testing plan that you need to do 
to uncover these statistics, consider this scenario: Imagine yourself trading a 
system that you knew had a win to loss ratio of 60/40. You made profit on every 
six trades and lost one out of every four. How do you think you would feel, 
where would your confidence level be, after you traded the system for a little 
while and you received a string of 11 losses in a row? 
Now, you know that this system has a win to loss ratio of six to four. Would 
you have the confidence to open another trade if your system brought up another 
buy signal after getting 11 trades wrong? 
Unless you use Day Trading, Forex or Currencies back testing plan to back 
tested your system, I doubt that your confidence level will remain high. That 
trading system may be a fantastic profitable system. However, since you didn't 
use your Day Trading, Forex or Currencies back testing plan to back test it, you 
don't know that historically this system received up to 13 losses in a row, but 
was still profitable.
Here's another point you may not have picked up unless you used your Day 
Trading, Forex or Currencies back testing plan. Once you've set your money 
management rules and you begin to trade, you will likely experience a string of 
losses. Countless times, I've had clients who get disheartened by this fact 
because they don't understand the nature of setting good management. If you're 
adhering to the rules of cutting your losses short and letting your profits run, 
because you're cutting your losses short, those trades are going to last for a 
shorter amount of time.
This means once you begin trading the odds of getting losses early in the 
game are much higher than getting a winning trade. This is particularly true 
when you consider that many successful trading systems run on a 40/60 win to 
loss ratio. However, you will never know the intricacies of your system unless 
you use a Day Trading, Forex or Currencies back testing plan and back test 
it.
Using a Day Trading, Forex or Currencies back testing plan, will help you to 
understand what works and what doesn't. It will give you the statistics to gauge 
the effectiveness of your trades. It fills in your scorecard, and allows you to 
make improvements. But, you shouldn't simply believe everything I've told you. 
Instead, you need to prove it to yourself by using some Day Trading, Forex or 
Currencies back testing plans and back test your system.

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