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.