Any source of currency trading information will tell you that you will need to test a foreign exchange system prior to going live but how precisely can you do that? The reality is that you should do it in more than one way.

Back Testing

Back testing a foreign exchange system involves scrolling thru the historical charts looking for eventualities that would have triggered a trade under your system and recording what would have occurred if you had opened a trade at that point. Historic charts are provided free on many FOREX trading information websites.

It is critical to apply the guidelines of your system in a pragmatic way when back testing. So for instance, if you’re using an EMA crossover system, you might spot a crossover on a past chart that was followed by a two hundred pip rise. Do you write down that you would have made two hundred pips from that trade?

No, it is unrealistic. First you may have spent a minute or two checking the signal against other time periods or other signals. Most systems need you to do that. In that time the price could have modified.

Then you’ve got to think about where your stop-loss would have been and whether there were any fluctuations that would have caused your stop loss. If there were, you have to record a loss even though there was potentially a 2 hundred pip profit.

Ultimately, consider where you would have closed the trade. If your system aims for 100 pips profit per trade, you would have closed at this point and missed out on the rest of the price movement. If your system involves closing 1/2 a successful trade, you may work out what your exact profit would’ve been, applying that method.

Understanding how to read candlestick charts is needed for both stock trading and foreign currency trading. Candlesticks are a record of price movements that will help a trader to identify trends and spot imminent breakouts and reversals or retracements. Many traders may be able to develop worthwhile trading systems virtually totally on the basis of candlestick charts, and many more systems depend on them as a first or first signal.

The chart is made up of a series of blocks or candles, each one showing the open, close, low and high costs over a period. These can be costs of anything: stocks, commodities, currencies or whatever. The open and close prices might be the costs for a day’s trading but mostly you have control over the period and you can set your chart to show a candle for each hour, for five mins or whatever. If you are planning systems around this kind of chart you may doubtless need to test your signals over more than one time period before you open a trade.

If shown in monochrome, the candle will be unshaded or white for a fee that rose during the period. In this case the open price is the bottom of the candle’s wide block and the close price is the head of the block. If the price dropped during the period, the body of the candle will be shaded, either black or a color. In this situation of course the upper edge of the body is the open price and the lower edge is the close.

In both cases, the high during the period is the top of the vertical line or wick stretching upward from the apex of the block. The low during the period is the base of the vertical line or wick running down from the bottom of the block.

Some charts nowadays are shown in 2 colors. You may have green or blue for a bullish period when the price was rising and red for a bearish period when the price was falling.