Backtesting is a systematic process of evaluating a trading strategy using historical market data to see how it would have performed. It allows traders to test ideas without risking real money. To backtest a forex strategy, you need to define the rules for entries, exits, stop-loss levels and position sizing. These rules should be clear and objective so they can be applied consistently to past data. Modern trading platforms and spreadsheets can run these rules across years of price data and calculate metrics such as net profit, drawdown, win rate and risk-reward ratio.
When reviewing backtest results, traders should pay attention to both profitability and consistency. A strategy that produces a smooth equity curve and small drawdowns is generally more robust than one that relies on a few large trades. It is also important to account for realistic trading costs, including spreads and slippage, because ignoring these can overstate performance. Over-optimizing a strategy to fit historical data — a mistake known as curve fitting — can lead to poor results in live markets, so keep parameters simple and avoid excessive tweaking. Once a strategy shows promise in backtesting, forward testing in a demo account helps verify that the approach holds up in current market conditions.