Are You Backtesting Correctly ? : Six Common Technical Mistake That Will Make Your Simulations Useless

When simulating the performance of a trading strategy using historical data within the Metatrader 4 platform there are many things that you can do which will inevitably end in bad performance and unreliable results. Many of the reasons why people regard backtesting using Metatrader as unpredictable and difficult to reproduce are a consequence of one or several technical problems which can arise due to the lack of carefulness of the trader running the evaluation. Knowing about these problems and taking action so that they do not affect simulations is something necessary to arrive at reproducible and reliable results. I have proved - within several trading strategies - that simulations can be reliable and easily reproduced if special care is taken to avoid technical pitfalls.

Within the following paragraphs I will share with you the six main technical reasons why traders arrive at unreliable simulation results that greatly over or under estimate the profitability of their trading systems. These problems can be easily avoided through some simple measures that can ensure that simulations are as reliable and useful as possible. Falling into just one of these problems can cause back-testing results to be utterly meaningless so avoiding them is of primordial importance for anyone interested in the accurate evaluation of trading systems and expert advisors. These are the technical problems you might encounter :

1. Using a 4 digit broker to run simulations. Many people think that the most accurate simulation results for their systems are obtained when running backtests with their broker's Metatrader 4 platform. However they do not realize that backtesting data is ALWAYS downloaded from metaquotes servers and that the 4 digit broker data set downloaded from Metaquotes contains MANY errors which make simulations totally unreliable. There are major gaps in price in the lower time frames, many daily candles missing large segments of volume, introduction of Sunday daily candles on some years, etc. If you want your simulations to be reliable you need to use and ONLY use five digit brokers for backtesting which download the much more reliable five digit data set from metaquotes.

2. You are using the weekend spread. Another very common technical problem people come across is the running of simulations on the weekend when the spread is extremely high in some cases. When you run a simulation during the weekend using this spread values you will have much worse results than what you would have when using the regular spreads provided during the trading hours of the week. In the end you should always perform your backtests in trading hours or change the spread within the Metatrader 4 platform (we use a script in Asirikuy in order to achieve this).

3. Your strategy trades below the 1 hour chart. During the past few years I have tested and run live/back testing consistency analysis of several strategies that run within the 30 min, 15 min and 5 min time frames only to find out that their results are each and every time inconsistent with simulations. The reason why this is the case is because the lower the time frame the more prominent the effect of one minute interpolation errors when determining things such as indicator values becomes. The broker dependency also increases exponentially and when trading 5 minute charts it becomes so high that the simulations are utterly meaningless. The fact is that variability caused by broker dependency and interpolation errors within these time frames is SO high that you can have totally different results between your backtests and reality. The problem is less pronounced for the 15 minute chart and only a small effect occurs on the 30 minute chart but the problem is not almost completely eliminated until you move to at least 1 hour charts.

4. Your Take Profit and Stop Loss values are within 10 times the spread of the instrument you are trading. When you are running simulations of systems that use these type of trading obtaining reliable results is impossible, not only due to the problem with one minute interpolation errors (which for this case is huge) but because of execution variables (such as re-quotes and spread widening) which prove to be VITAL in the actual real-life profit of these strategies. If you want your simulations to mean something and provide you with some approximation to valid profit and draw down targets then your average Take Profit and Stop Loss must be above 10 times the spread.

5. You are not recalculating your data before each backtesting run. Something which is extremely important is the recalculation of data before starting each new simulation. When you load a chart or when your demo feed sends a tick to your platform there are sometimes history recalculations which corrupt your data and cause your simulations to become erratic and invalid. In order to correct this problem you must recalculate your data within the history center before running every back-test. This can be achieved by going to the one minute section of the instrument you want to recalculate within the history center and clicking the download button until it prompts you to recalculate data. Doing this ensures that your data will not suffer from corruption from your demo feed.

6. You are running a backtest over the last 1-3 months. Your historical data is composed of the data you download from Metaquotes servers and the data you obtain from your live/demo feed from your broker. The last 3 months of testing data are usually downloaded from your broker while the data before pertains to the history center. Usually if there is a time stamp mismatch between your platform's live feed and the Metaquotes data there will be massive generation of errors within the past 3 months of data as the program gets "confused" from these differences. If a chart of the instrument you want to trade shows massive gaps after you do a historical data recalculation then this is a problem. You can generally avoid this by only running backtesting that end three months before the current time.

Certainly the metatrader 4 platform has many limitations and the above restrictions limit us to the development of certain kinds of trading strategies. However this doesn't mean that simulations are unreliable but mainly that great care has to be taken in order to make the backtests reliable, reproducible and coherent with live trading results. By following all the above suggestions and avoiding this technical pitfalls you will be able to obtain reliable backtests of your trading strategies which will allow you to get a good picture of the possible long term performance of your trading strategies.

If you would like to gain a true education around automated trading systems and how you too can design strategies that achieve reliable simulations with accurate profit and draw down targets please consider joining Asirikuy.com, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach automated trading in general . I hope you enjoyed this article ! :o)