The global financial markets are becoming more dynamic every day with transactions growing to record highs. The foreign exchange market is at the center of this massive growth as it continues to post huge daily transaction volumes, which now go past the $3.4 trillion levels.
Due to this dynamic shift in global trading, investors are continuously seeking new ways to beat the market and pocket sizeable gains on their investments. Among the ways being sought after is automated trading. A rule-based analytical way of trading various currency pairs, ETFs and CFDs among others with minimal interaction with the market.
How is this possible? Well, people have been doing it for years and it has proven to be one of the most successful ways of engaging in the market, especially from the point of view of minimizing the risk of loss.
However, in order to utilize this form of trading to a great effect, traders must first put the various rules and strategies they intend to use into test based on past performance in a technique called backtesting. Traders must backtest the various strategies on the instrument they intend to apply the technique on based on past statistics.
So what exactly is backtesting?
Generally, backtesting involves looking at a particular strategy that you intend to apply in trading a currency pair or ETF, etc, from a distant date in the past. In other words, a trader looks at a similar opportunity in the past, preferably a similar time and tries to evaluate how applying the strategy he intends to use would have worked then.
This also involves assessing the time it would have taken the strategy to close, make profit/loss and the prevailing market conditions then. The two scenarios have to be as similar as possible for the strategy to be near 100% perfect.
The strategy can involve several rules that instruct an automated system to take various actions based on the trader’s requirements, such as if the GBP/USD touches the 1.54 levels, the enter a Buy order with a stop loss at 1.52 levels and a profit target at 1.58 levels.
In this case, the trader may not need to test the strategy on exact levels but the pattern of the currency pair movement has to be similar. For instance, if the current trend is a declining wedge characterized by a series of dips and rebounds (lower highs and lower lows) then the backtesting period’s trend in the past must display similar characteristics.
Why is this important for automated trading?
Well it is quite simple. Automated trading is a hand-off form of trading that does not require the trader to keep a close eye on the price movements of his selected trades. This means that applying the wrong rules and strategy at the wrong time and on the wrong currency-pair or trading instruments could end up being a total financial calamity.
Therefore, in order to minimize the risk of financial loss, a trader needs to test his strategy against similar opportunities in the past, and as described earlier, this process is called backtesting.
Now in order to perform such processes, a trader needs to use a system that allows backtesting. There are several out there, but it is always good to check on various reviews about the systems in the market.
Choosing the right system is crucial for a successful automated trading. Note that, with automated trading, traders do not need to interact with the system frequently, but only require setting up their trading strategies based on their coded rules for targeted profits and risk appetite.
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