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What Would You Rather Do: Read About Someone Elses Forex Success Or
Experience Your Own
By: David Jenyns
You can draw some useful parallels between running a business and Forex 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 Forex back testing plan in your trading works
exactly the same way.
Now that you`re looking at Forex 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 Forex 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 Forex back testing plan.
There are two ways that you can use a Forex 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 Forex back
testing plan works in all its intricacies. Once you have the Forex 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 Forex 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 Forex 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 Forex 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 Forex 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 Forex 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
Forex back testing plan and back test it.
Using a Forex 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 Forex back testing plans and back test your
system.
About the Author:
Discover BIG profits from the market by downloading your FREE copy of David's
new Ultimate Forex Trading Systems course. http://www.ultimate-trading-systems.com/forex.htm |
