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Forward Testing of Trading Strategies

Forward testing, also known as paper trading or walk-forward testing, is a crucial step in validating a trading strategy under real market conditions without risking actual money. It bridges the gap between theoretical expectations, backed by data, and practical application in a live market environment.

By carefully executing forward testing, traders can validate their strategies and build the confidence necessary to transition to live trading. In this guide, we will focus specifically on manual forward testing to ensure hands-on experience and deeper insights into your trading approach.

While forward testing, you will encounter additional conditions that are not easy to simulate using the historical data on which your backtest was likely based. These elements include:

  • Filled and Unfilled Orders: Orders may not always get filled at the expected price, affecting both trade entries and exits.
  • Slippage: The difference between the expected price and the actual price at which a trade is executed can lead to unexpected losses or smaller profits.
  • Spread: The difference between the bid and ask price can vary, impacting your trade costs and profitability.
  • Trading Fees: Commissions and fees can add up, reducing your overall returns.
  • Swap Fees: Holding positions overnight may incur swap fees, which can affect the profitability of longer-term trades.
  • Mental Aspects (in a Reduced Form): Emotions like fear, greed, and impatience, while minimized in forward testing, can still influence decision-making and your final decision whether the strategy is tradeable for you and fits your daily schedule.

1. Prerequisites

  • Trading Playbook: Before beginning forward testing, you should have a well-prepared trading playbook. This should include your notes, screenshots, and ideas gathered throughout your trading studies. It serves as your personalized guide to executing trades based on your strategy. If you need help creating one, we have an entire lesson dedicated to it.
  • Trading Journal: Keeping a trading journal should be your top habit. This journal is where you track your performance in a consistent and organized manner. It can be tedious, but it’s essential for maintaining a clear record of your trades. Our lesson on maintaining a journal will guide you on how to do this effectively. Remember, your journal should provide statistics that align with your backtesting results.
    • Additionally, you can use the parallel trading journal to compare executed trades with those you missed—whether due to hesitation, absence from the computer, or any other reason. 
    • This adjustment maintains the clarity of the original point while incorporating the added detail about misinterpreted visual cues and chart patterns.
    • See our lesson on how to keep a trading journal for more tips and information.
  • Backtest and Trading plan: While backtest focuses on the data and statistics, the trading plan should describe the whole trading process for trading a backtested method. The expectations of a positive outcome, based on its statistics, should help you maintain a consistent approach. By relying on the data and strategy you’ve developed, you can stay disciplined and avoid deviating from your plan during both favourable and challenging market conditions.
  • See our lesson on preparing a backtest and a trading plan. 

2. Selecting a platform and broker

When selecting a platform for forward testing, it’s advisable to choose one that closely resembles the platform you’ll use with your actual broker once you transition to live trading. The choice is relatively straightforward, as the options available to retail traders are not overly numerous.

  • Demo Accounts: Many brokers, such as FTMO, offer demo accounts, with the vast majority of traders utilizing MetaTrader 4 or 5. These platforms are popular among traders due to their extensive community support, with numerous plugins and customization options available. Although MetaTrader dominates, a smaller group of traders prefer cTrader for its superior design and out-of-the-box functionality.
  • Paper Trading Platforms: TradingView is a leading web-based trading platform that runs directly in your web browser. Even its free version is highly suitable for paper trading, providing a virtual account and detailed performance statistics.

3. Set Up Your Trading Environment

  • Mimic Real Trading Conditions: Set up your demo account or paper trading account to reflect the same conditions you would use in live trading, including your starting capital, leverage, and the currency pairs or assets you plan to trade.
  • Check the Rules: all the rules and parameters from your backtested strategy should be clearly defined and described in your trading plan. This includes your entry/exit criteria, stop-loss and take-profit levels, position sizing and restrictions that will tell you when to stop trading and evaluate your progress.
  • Test flight: Ensure you’re familiar with the tools you’ll be using to set up your trades, such as position sizing tools or calculators, and the platform’s functions for entering and closing trades. Take the time to get comfortable with the size of your account, as it directly influences your trading decisions regarding position sizes and affects your mental state during open positions—whether they are profitable or losing.

4. Trade as You Would in Real Life

  • Follow Your Strategy: Execute trades according to the rules of your strategy exactly as you would if you were trading with real money. This is crucial for gaining an accurate understanding of how the strategy performs under live conditions.
  • Record Each Trade: Keep a detailed trading journal, noting down the entry and exit points, the rationale behind each trade, and the outcome. Include screenshots of annotated charts if possible to visualise market conditions at the time of the trade.

5. Evaluate Psychological Impact

  • Real Emotions: Even though no real money is at risk, try to approach forward testing with the same emotional discipline you would use in live trading. This helps you understand how you might react to losses, wins, and market fluctuations.
  • Recognize Behavioural Patterns: Note any tendencies to deviate from your strategy, such as holding onto losing trades too long or taking profits too early. Forward testing is an excellent time to develop strong trading habits.

6. Adjust and Refine Your Strategy

  • Analyse Results: After sufficient trades and time, analyse the performance. Compare it with your backtested results to identify any discrepancies or areas of improvement.
  • Make Adjustments: Based on your observations, you may need to tweak certain aspects of your strategy. For instance, you might adjust stop-loss levels, entry criteria, or position sizing to better fit live market conditions.
  • Retest if Necessary: If significant changes are made, you might need to return to backtesting and then forward testing again to ensure the revised strategy is still viable.
  • Project the niumners using equity curve generator, estimate how many stop losses in a row is expectable, prepare your head

7. Transition to Live Trading

After successfully completing forward testing, it’s time to transition to a live or prop trading account. The key difference between demo/paper trading and live trading is the presence of real risks and profits. While starting with demo or paper trading is a good idea, it’s important not to delay too long before moving to a live account, where your actions have tangible financial outcomes and fully introduce the emotional aspects of trading.

  • Small Scale Start: Begin live trading with a small portion of your capital, such as around $200 USD or an equivalent amount. This approach should allow you to properly size your trades on a small variety of instruments and further validate your strategy under real-money conditions.
  • How Fast to Transition to Live?
    The speed at which you transition to live trading depends on the average number of situations your strategy generates within a given timeframe. A good threshold is to experience between 20 to 100 situations (trades) before making the move to live trading.

    • If your strategy generates fewer situations per day, week, or month—such as those based on higher time frames or more complex strategies—testing may take longer. However, if you encounter no issues with execution or trade management, you may consider shortening the process.
    • The timing also depends on your personal need for assurance. If you’re confident in your strategy’s performance, you can transition sooner. However, if you need more reassurance, extend your testing period to ensure consistency across various market conditions.
    • Be cautious, though, of falling into the trap of endless testing, where some traders never progress to live trading because they continually test without taking action.
  • Consider Prop Trading: The smallest FTMO challenge, for example, is priced to be an attractive alternative to the live brokerage account, limiting your risk on your own capital while providing a structured environment for live trading.
  • Scale Up Gradually: As you gain confidence and see consistent results in your live trading, gradually increase your position sizes and capital allocation. This is where the real big profits can be made, but it’s crucial to prepare yourself mentally for the challenges that come with sizing up.

Key Points to Remember:

  • Discipline: Treat forward testing with the same seriousness as live trading to develop strong habits.
  • Journaling: Keep a detailed record of each trade to track your performance and identify areas for improvement.
  • Patience: Allow sufficient time for your strategy to be tested across different market conditions.
  • Consistency: Apply your strategy consistently without deviation to ensure reliable results.

By carefully conducting forward testing, you can refine your strategy and build confidence before risking real capital.