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Forward Testing - By TrendFollower

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A lot of traders will discuss the importance of 'back testing' their trading systems but very few on the IG Community discuss 'forward testing' their trading systems which in my opinion is just as if not more important.

Now I shall try and keep things as simple as possible with the IG audience in mind.

So first of all what is 'forward testing'. It is a way of measuring and testing your trading system in live market conditions or as close as. Some may use 'demo accounts' to do this and others may actually use live accounts but trade with the smallest capital possible and smallest trade sizes to really assess the trading performance of their trading system in a 'live market environment'

Now how many years you go back in your 'back testing' and how many years you go forward in your 'forward testing' is a decision that the individual trader has to make. Many traders will simply not forward test and will never do so. They will not have this decision to make. For those who do decide to really fine tune and improve their trading system then I think this is a necessary decision to make.

Some of the traders I know will forward test one year for every three years of back testing they conduct. So six years of back testing would require two years of forward testing before that specific trading system goes live. Now this is just one example and it is not not necessarily the right example. It will be all to do with the asset in question, the trading system in question and the market conditions. I know one trader who has been backtesting and forward testing their trading system for the past few years and still has not gone live. Now this is overkill for me as in this period the trader is missing out on some of the strongest trending opportunities to profit from. So there needs to be a sensible and reasonable balance. 

Back testing is all about historical data. Forward testing is all about live (real time) data. I have known traders to perform forward testing by just keeping data on a spreadsheet of how a trade would have performed in current real time market conditions without actually using any real money. I personally do not like that method. I personally want to use real money and actually physically trade albeit the smallest amounts possible to get as close to real life trading performance to really understand the performance, any flaws or issues with my trading system. 

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I think one must be careful that the time period of any 'Forward Testing' is significant enough to make a real impact on your trading strategy.

I remember when I was looking at trading Natural Gas many years ago, I forward tested for a couple of months and it simply was not enough. At the time I paid the price as my trading system clearly had flaws and I lost a lot of money trading Natural Gas. The volatility killed my account as my stop losses were far too tight. I have heard someone on the IG Community suggest or infer not to use stop losses. I would urge that person to try trading Natural Gas without stop losses. It would be extremely dangerous based on my personal experience. I had stop losses and still ended up losing money. Now I am talking about around 15 years ago. 

Some people may think that your trading system must include super complex algorithm. Your trading system can be as simple as you want it to be but I still think you need to forward test it. Having a more complex trading system does not necessarily mean you will have more / higher profits at the end of each year. However, if you have conducted 'forward testing' for a reasonable amount of time then it could help you to minimise your losses. Losses will still be incurred and no amount of forward testing can stop or completely eliminate that but it could help with damage limitation should you effectively use the data / results obtained from the forward testing and apply it to your trading strategy / trading system. 

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