There are many trading strategies available on the internet. But how do you know if your trading strategy is profitable?

**A trading strategy is considered profitable if it gives positive results in backtesting and/or forwardtesting. The results must meet the trader’s return requirements and must pass through a series of filters to ensure that the results accurately represent the actual trading conditions. **

It’s a bite, so I’ll break it all down for this tutorial.

We will explain how to define profitable strategies and how to conduct tests to understand the performance of trading strategies.

Then combine these two factors to see if your trading strategy is really profitable.

## back test

**The fastest way to determine if your rule-based trading strategy is profitable is to backtest it. **

Backtesting can be done on any trading market.

If you can see that a trading strategy is profitable over the long term, it is the best indicator that the strategy is likely to work now and in the future.

Some people think that backtesting requires knowing how to code a computer program.

it’s simply not true.

*Both manual and automated backtesting can be performed.*

Anyone can backtest.

This software makes manual backtesting a breeze.

You can also backtest using a free charting platform.

The question is which one is easier for you.

**Every profitable trader is looking for a trading strategy with a historical edge in the market. **

Once you have proven that your strategy has been profitable in the past, you also have important data on how the strategy performed.

You know things like…

- Maximum number of consecutive losing trades
- average monthly return
- maximum drawdown
- Market conditions when strategies work and when they don’t
- more

All these data points allow you to make important decisions about your trading strategy. This will be covered in more detail later in this tutorial.

Think about your car…

We all know that certain makes and models of cars last longer, while others fail quickly.

The reason we know this is because we have **historical data** It shows the reliability of these cars.

For example, Toyotas are generally very reliable cars.

Fiat, on the other hand, is notoriously unreliable. Many people say that Fiat stands for “Fix It Again Tony”.

If you buy a car from a company that just started producing cars last year, you don’t know the reliability of that car because it has no track record.

So you are taking a big risk.

**Likewise, you need to know the track record of your trading strategy before risking real money. **

*Again, backtesting is the best way to do that.*

If you’ve never backtested before, this beginner’s guide will show you how to get started and the best tools to use.

**Backtesting also provides one of the most important characteristics a trader can have: resilience. **

When I make a trade, I have a high level of confidence in my chances of winning the trade.

I’m not exactly sure how the individual deals work.

*But if you do a lot of trades, you will find that X% of trades are profitable. *

of **Fastest** Find X% probability and expected return by backtesting.

Knowing the backtesting stats of your trading strategy is also useful when you are on a losing streak.

All trading strategies have a losing streak, but we would like to be able to separate the normal losing streak from situations where the trading strategy might have stopped working.

For example, let’s say you had a maximum of 7 losing trades in a row in your backtest.

That’s normal for that strategy.

However, some traders, once they start live trading, get freaked out when they see three losing trades in a row and think the system is broken.

If they have backtesting data and see their maximum losing trades in a row, they will find that 3 consecutive losing trades are well within the normal parameters of the strategy.

Nothing to worry about.

The same is true for other data points obtained in backtesting.

**So having this data gives you the confidence to keep trading when you hit a rough patch. **

## forward test

Another way to determine if a trading strategy is profitable is the forward test.

This basically means opening a demo account or “paper trading” to build a track record for your trading strategy.

*No real money is at risk when forward testing. *

**The main advantage of forward testing is that you can know in real time whether your trading strategy is currently working.**

On the downside, it can take a long time to gather enough data to determine if a trading strategy works.

I see so many new traders make the mistake of forward testing their newly learned trading strategies with real money and full size accounts.

They believe a trading strategy works because someone told them it works.

Then you wonder why you lose money.

*Don’t just take someone’s word that a strategy works, always test and validate it.*

**If you only do forward testing, you need enough trades to be confident that the strategy is profitable.**

Some people are saying online that 100 trades is the minimum number of trades required to properly test the system.

it’s not true.

This video explains how to figure out the minimum number of trades.

This video discusses backtesting, but the same concepts apply to forward testing.

Alright, once you have a few comfortable trades, let’s move on to the verification stage.

## double check the results

**If you get data on your trading strategy and it’s profitable, take a step back and consider if you’re missing something.**

*There may be assumptions made in testing that do not carry over to real trading.*

### broker’s quote

For example, using data from Broker A and starting a live trade on Broker B can yield very different results.

The reason is that the forex market is decentralized.

**Therefore, there are slightly different price quotes for each individual broker.**

Historical data influences strategies for shorter timeframes. Small differences in quotes usually do not have a large impact on daily charts or any trading system beyond.

Short-term trading strategies, however, are more sensitive to quote differences due to their much smaller margin of error.

Since Stop Loss and Take Profit are small, price deviations have a large impact on the profit and loss of every trade.

### Spread

**Another common thing people tend to overlook in testing is diffusion.**

This is especially true for backtesting.

If you don’t consider spreads on all your trades, your strategy looks much more profitable than it actually is.

You might think this is common knowledge, but you’d be surprised how many people overlook it.

But don’t stop at these two examples. Consider all the things that can differ between testing and real market conditions.

Once you are satisfied that your test results adequately represent real trading conditions, it’s time to ask yourself an important question…

## Understand the definition of profitability

**Now here comes the big problem…**

What is your definition of profitability?

The answer may seem simple, but it’s not.

To illustrate my point, I’ll start with an extreme example.

Let’s say you’ve backtested your trading strategy over 20 years and you’ve totaled 5%.

So if you started with $10,000, your total profit would be $500, or an average of $25 per year.

Is your trading strategy profitable?

of course.

But is it profitable enough to make a living?

no way.

Therefore, I do not consider that trading system to be profitable.

Taking into account the profit the system generates in relation to the time you have to spend on it, you will lose money with that trading strategy.

As such, there are several factors to consider when creating a profitability definition.

- Annual average return
- Time spent trading the system
- drawdown
- danger of ruin
- real world performance

**It’s all a matter of what’s important to you, how much risk you’re willing to take, and the return you want to get.**

Everyone wants to earn 800% per annum, but can you handle the risks associated with that return?

For most people the answer is no.

This leads us to another important question…

## How much can you realistically expect to earn annually from trading?

When you’re just starting out trading, it can be difficult to know what’s possible in terms of consistency and annual returns.

So the best way to figure this out is to look for as many data points as possible.

Listen to interviews with professional traders.

Let’s look at achievement of a trading system similar to the one you are testing.

This will give you an idea of what is possible and likely.

…and it will give you more confidence.

## final thoughts

This is a complete guide on how to determine if your trading strategy is profitable.

**As you can see, the concept of “profitability” is a very relative term. **

What you consider acceptable profit levels can be very different from what I consider acceptable.

Also, the risk and consistency of the strategy should be taken into consideration.

So first define how much profit you want to get from your live trading strategy.

Ask yourself if that number looks realistic based on what you see from live trading results for similar strategies.

Then test your trading strategy to get as much data as possible about your strategy.

From there, simply compare the results of your test to what you feel is an acceptable return.

There is no magic profit number in real world trading.

*It’s up to you to make the call.*

If your trading strategy meets the criteria, the next step is to open a small live account and start trading your strategy.

Trade your strategy for a few months and see if your real trading results are similar to your test results.

**Only migrate a strategy to a full-sized account if it worked well on a smaller account.**

All right, that’s your blueprint. Let’s get to work!