There are many trading strategies available on the internet. But how do you know if a trading strategy is profitable or not?
A trading strategy is considered profitable if it has a positive result in backtesting and/or forward testing. The results have to meet the return requirements of the trader, and go through a series of filters to be sure that the results are an accurate representation of real world trading conditions.
I'll get into how to define a profitable strategy and how to do the testing to figure out the performance of a trading strategy. Then you'll put those 2 elements together to find out if a trading strategy really is profitable or not.
Backtesting an indicator
The fastest way to figure out if a rules-based trading strategy is profitable is to backtest it.
Backtesting can be done in any trading market. When you can see that a trading strategy has a profitable track record over a long period of time, that's the best indication that a strategy is likely to work now and in the future. Some people think that you need to know how to code a computer program to backtest. That's simply not true. The MT4 platform offers a backtesting module "Strategy Tester" to allow you to test your indicator on historical prices.
Once you've tested an indicator and know it would have been profitable in the past, you'll also have key data on how that indicator performs.
You'll know things like…
The maximum number of losing trades in a row
The average monthly return
The biggest drawdown
Market conditions when the strategy works and when it doesn't
And more
Another way to figure out if a trading strategy is profitable is to forward test it. This basically means that you open a demo account or “paper trade” to build a track record on a trading strategy.
Forwardtesting
The primary advantage of forward testing is that you'll know if a trading strategy works right now, in real-time.
On the downside, it can take a long time to collect enough data to determine if a trading strategy works or not. I see so many new traders making the mistake of forward testing a trading strategy that they just learned, with real money and a full-sized account. They believe that a trading strategy works because someone told them that it works. Then they wonder why they lose money.
Never take someone's word that a strategy works, always test and verify. The advantage of the #3crSqaud is that you have many traders usingthe strategy and providing social verification that it works.
If you're only going to forward test, then you need to have enough trades to give you confidence that a strategy is profitable.
Some people online say that the minimum number of trades that you need to have a properly tested system is 100 trades but the reality is that you should try and get as many data points or results as possible - the more data, the more robust and reliable
the statistical results.
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