Backtesting in Metatrader 4: Everything you need to know

The backtesting process can be conducted in two ways: automated or manual. The automated method involves using a strategy tester, which can be in programs such as MetaTrader 4 or 5. For this, you need to parameterize and codify the strategy, and then the system itself performs the test and provides the results.

On the other hand, the completely manual approach involves planning the strategy and then reviewing historical data through the asset's chart. This includes identifying when a signal occurred, noting the price and time, and then examining how far the price moved afterwards—both upward and downward—how long the signal lasted and any other relevant data for the strategy. All this information is then compiled and calculations are performed once a significant number of samples have been collected.

The manual system can require a significant time investment. However, at least once, it is useful to carry out this process to better understand the background of automated backtesting. It also serves as a learning experience for optimizing the system, in addition to providing valuable insights when analyzing price movements in detail.

Through backtesting, traders assess the effectiveness of their strategies by applying them to historical data. Essentially, if backtesting yields positive simulation results in terms of returns, there is a higher likelihood that the strategy will perform well in a live environment, at least for some time.

Traders can use MetaTrader 4 to automatically test their trading strategies. This is a powerful tool and one of the reasons why MT4 is considered a comprehensive platform. Another method of backtesting is manual. MT4 facilitates this process since you can go back in time using the chart, make notes, draw trends and view data in detail. You can save all your notes and resume backtesting when possible. Thus, MT4 is an excellent tool that allows for automated backtesting and is also very useful for conducting 100% manual backtesting.

To perform backtesting, whether manually or through Expert Advisors (EAs), one of the first things to consider is the data. It may be necessary to download historical data for the assets. This ensures that all necessary data is available, avoiding potential errors and inefficiencies in the backtesting process. The data can be downloaded in the History Center (Tools > History Center). You have to find the asset and the relevant timeframe, and then import it into your system. After doing that, you will have the required data for backtesting.

To test a strategy automatically in MT4, the first step is to open the ‘Strategy Tester’ feature in the terminal. This is done by going to the ‘View’ menu and selecting ‘Strategy Tester’. The corresponding window will appear on the screen, where the entire backtesting process takes place.

To conduct backtesting using Expert Advisors in MT4, the next step is to select ‘Expert Advisors’ in the drop-down menu, which allows you to choose a specific EA program. Before this, the EA program must be installed and dragged to the tester platform. You can either download an existing EA from the internet or create your own.

Then, select the symbol (the assets being tested) and below that, select the period (timeframe). The next step is to choose the Model: Every tick, Control points or Open prices. MT4 states that Every Tick is the most accurate method, as the others might produce errors. Next, you must select the Spread, which can be introduced manually or the current one.

The Expert properties section is where you define the initial deposit, the currency and the type of position (long, short or both). There is also an optimization area where you can specify which parameters you want the strategy optimized for (Balance, Profit Factor, Expected Payoff, Maximal Drawdown, Drawdown Percent or Custom). This area allows you to provide more specific details about your preferred position. Next, select the date and any other available options. To begin the test, click ‘Start’, and the test will begin. You can check the ‘Journal’ tab to see how the process is progressing. Once the test is complete, you will see the performance of each trade in the ‘Results’ tab. The ‘Graph’ tab shows the capital progression, and the ‘Report’ tab provides a summary with all relevant details such as Profit Factor, Total trades, Gross Profit, Maximal Drawdown, Expected Payoff, Profit per trade, Consecutive wins, Long positions won/loss, Short positions won/loss, among other figures. A chart will also display the moments when each operation was opened and closed.

The duration of the testing depends on the computer's speed, the configuration of the operation, the chosen historical data period and the complexity of the EA. It is recommended to start with very short periods to evaluate if the parameters are correct and to resolve errors, before moving on to longer periods or adding new parameters to the EA.

The results obtained will show whether the strategy worked in the past or not, how effective it was and its reliability, among other important points such as drawdowns.

Advantages

Refining a strategy: Backtesting is an excellent tool that can either validate a strategy or, conversely, cast doubt on its effectiveness. Furthermore, the backtesting process helps optimize and adjust the parameters of a strategy to achieve better results and ultimately define a strategy that can yield positive performance as a trader. Backtesting can be performed indefinitely, and in each instance, different configurations can be tested until the trader finds the optimal one.

No capital risk: The backtesting process is an estimation, so the trader does not risk any actual money. It is a great way to learn about market trends without financial exposure.

Speed: Automated backtesting through Expert Advisors (EAs) allows traders to conduct complex backtesting processes quickly. What might take considerable time if done manually can be accomplished efficiently through automation.

Market knowledge: Whether through automatic or manual backtesting, traders gain exposure to market movements, providing them with experience that is crucial for understanding market trends.

Market knowledge: To summarize, backtesting can provide traders with strategies that perform well, valuable experience and an effective tool for analysis. However, it also comes with certain drawbacks.

Disadvantages

Past data not necessarily predictive: Just because backtesting yields positive results do not guarantee that these results will replicate in the future. Historical data is not always a reliable predictor of future market behavior.

Bias: Traders may choose a model based on past results, but they might not account for changing conditions in the future or even present circumstances that require a different strategy. The risk of bias also indicates that traders can manipulate data to obtain favorable outcomes.

Data quality: Backtesting requires datasets to be efficient and complete; incomplete or inaccurate data can lead to models that do not consider current market conditions.

Constant updates needed: Despite backtesting being automated and relatively quick, the resulting strategy needs to be monitored and adjusted based on changing market conditions. This means that even after significant time spent developing a strategy, ongoing adjustments may be necessary. Traders must remain vigilant, as what works under certain conditions may not be effective under different circumstances. For instance, a strategy may perform better in a bullish market than in a bearish one.

Constant updates needed: Despite backtesting being automated and relatively quick, the resulting strategy needs to be monitored and adjusted based on changing market conditions. This means that even after significant time spent developing a strategy, ongoing adjustments may be necessary. Traders must remain vigilant, as what works under certain conditions may not be effective under different circumstances. For instance, a strategy may perform better in a bullish market than in a bearish one.

Costs:Introducing costs into the backtesting process, such as spreads and commissions, can significantly affect results. Many platforms have variable spreads that could be overlooked in both manual and automated backtesting.

Slippage: In manual backtesting, the actual trading circumstances may differ from those evaluated in the backtesting process. Real-time trading often experiences slippage.

While technology, platforms and data allow for extensive historical backtesting, it may not always be advisable to use all available data, as market conditions continually change. Thus, determining an appropriate starting point for backtesting is crucial, ideally around the time the strategy begins to exhibit positive results. Using a relevant historical timeframe is essential. This highlights that designing and testing a strategy is not an easy process, and despite automation, it still requires human intervention. All automated tools serve as aids that traders can use effectively or poorly.

Despite its potential drawbacks, backtesting remains a valuable component of a trader's learning curve. Conducting manual backtesting—documenting each trade, marking it on the chart and subsequently optimizing—provides insights into how the system operates. This process enhances understanding of how to better parameterize the system.

Beyond the insights gained from backtesting, the process itself allows traders to observe price movements, leading to a deeper understanding of an asset and how its technical indicators react over time. Ultimately, even a negative backtesting outcome can significantly enhance a trader's experience and contribute to their growth.