Backtesting is the process of feeding historical data to your trading strategy to see how it would have performed. The hope is that its historical performance tells us what to expect for its future performance. The importance of this process is obvious if you have developed a binary options strategy from scratch, since you would certainly want to know how it has performed. But even if you read about a strategy from a publication, it is still imperative that you independently backtest the binary options strategy. There are several reasons for this.
Often, the profitability of a strategy depends sensitively on the details of implementation. Ideally, our backtesting program can be transformed into an automated execution program by the push of a button to ensure the exact implementation of details.
Once we have implemented every detail of a binary options strategy, in a backtest program, we can then put them under the microscope and look for pitfalls in the process or in the strategy itself. For example, in backtesting a binary options strategy based on technical indicators, on the Mt4 platform with both buy and sell positions, we have to take into account the different advantages of the different types of technical indicators involved, some will work well in trending markets and others in ranging markets.
More importantly, when backtesting binary options strategy ourselves, we often can find ways to refine and improve the strategy to make it more profitable or less risky. The backtesting process in binary options trading should follow the “scientific method.” We should start with a hypothesis about an arbitrage opportunity, maybe based on our own analysis of the markets. We then confirm or refute this hypothesis by a backtest. If the results of the backtest aren’t good enough, we can modify our hypothesis and repeat the process.