Retail forex market has been swarmed with forex robots. Everyday you will find a new forex robot being launched with a lot of fanfare and tall claims. Now an important question that should come to anyone’s mind is that can you trust the screeshots shown on a forex robot website?
Most of these websites have been designed solely for the purpose of marketing and selling that robot. Almost all these websites talk about Back Test Results. Let’s discuss what these back test results mean.
First what is a back test? Back test is done using historical data on a particular currency pair. Back test is usually done to see the performance of an automated system under the past market conditions. So when you see a robot website, you will read how much it could have made in the last five or ten years. Suppose, you have historical data for the currency pair GBPUSD for the last six months. You perform a back test to check the performance of a robot with that historical data.
On the back test the robot is giving a very good performance. You are impressed. Now keep this in mind this is historical data. If the robot performed well in the past, there is no guarantee that it will do so in the future. When you back test, it simply misses the widening of spreads and the slippage that takes place during live trading. Let me explain more. When you are trading live, the spread widen if the liquidity thins in the market. If the liquidity in the market is good, normal spread can be like 2 pips. But in times of high volatility or low trading, liquidity thins in the market. The broker will widen the spread to compensate for this low liquidity in the market. In night when most of the banks and big corporations are closed, the liquidity in the market is usually thin. So most of the time, you will find the spread to widen to 3-5 pips during late hours.
When there is some economic news release, again liquidity dries up as most of the big players want to watch the market and stay out under volatile conditions. At the time of economic news release like the NFP Report or other important reports, you might find the spread to widen to as high as 20 pips. When you are doing the back test, these factors are simply being ignored. It is being assumed that the spread is the same say 2 pips. Now, you can well imagine how accurate a back test can be. It can only be a rough indication of the future performance of the robot and nothing more than that. So back testing simply ignores the widening of spreads and the slippage that are always present under live trading conditions.
This was the actual truth about back testing. What about forward testing? When you test a robot on a demo account, it is known as forward testing. When you do demo trading, you are using real time data but the money in the account is virtual or fake.
Demo accounts behave differently than live accounts. You should know this. In demo trading, you are using virtual money or fake money. This is one difference. Let me explain how this makes a difference. When you buy and sell, the broker has to find someone who can take the opposite position. This is known as offsetting.
This is done automatically through the broker’s trading server. Now this is not instantaneouly. It can take sometime. In some cases, it is impossible to find someone to take the opposite position to your buy or sell order. So what is possible on a demo account may not be possible on a live account. So what gets executed on a demo account maynot get executed on a live account. The only test of a forex robot is live trading.