Backtesting a GBP/JPY Forex Trading Strategy Using Ichimoku and RSI Indicators

1. Introduction

The dynamic world of forex trading constantly demands strategies that are both innovative and time-tested. The essence of any good trading strategy lies in its ability to predict market movements accurately and consistently. Backtesting plays a crucial role in validating a strategy's reliability. In this article, we venture into the synergy between two prominent indicators, the Ichimoku and the Relative Strength Index (RSI), and explore their combined might in forex trading.

2. Methodology

Data Selection

Symbol: GBP/JPY

Testing Period: From the dawn of 2021 to June of the same year, we assessed a 5-month period.

Timeframe: Trades and analyses were conducted on a 4-hour chart, balancing both precision and overarching trend insights.

Strategy Description

The Ichimoku, an indicator often used to gauge momentum and future areas of support and resistance, is complemented by the RSI's capability to identify overbought or oversold conditions. Trades are primarily initiated based on Ichimoku signals, refined and confirmed using RSI readings.

Entry conditions:

Price crossing the Ichimoku Cloud (Kumo)

RSI crossing above 30 (for buy) or below 70 (for sell)

Exit conditions:

Price crossing the opposite side of the Ichimoku Cloud

RSI showing signs of reversal (crossing below 70 for buys or above 30 for sells)

Backtesting Setup

With an initial footing of $10,000, we ensured that the maximum lot per trade did not exceed 3.00.

3. Backtesting Results

The results offered a comprehensive insight into the strategy's potential:

Performance Metrics:

Total trades materialized: 54

Successful forays: 33; Missteps: 21

The profit-to-loss ratio stood at a commendable 1.96, with an overall return of 247.62%.

Profits and Losses:

The net profit touted a whopping $24,762.31, derived from a gross profit of $36,707.03 and a gross loss of $11,944.73.

The zenith of success reached $4,642.05 in a single trade, while the deepest plunge was restricted to $1,282.94.

Monthly Analysis:

On average, 11 trades were executed monthly, leading to a profit of approximately $5,022.11 and an average monthly profitability of 50.22%.

4. Analysis of Results

Strengths:

The strategy, with its 82.00% reliability factor, showcased a consistent profit probability of 61.00%. The restoration factor at 4.06 suggests the strategy's capability to recover from drawdowns effectively.

Weaknesses:

The maximum drawdown, while substantial at $6,105.43 or 27.28% of the average balance, reminds traders of the importance of risk management and capital preservation.

Compared to other industry standards, this strategy's performance demonstrates a remarkable potential for consistent profitability, albeit with its associated risks.

5. Potential Improvements and Recommendations

While the synergy between Ichimoku and RSI is evident, traders might consider integrating stop-loss and take-profit levels to better manage potential losses. Additionally, periodic review and optimization based on market conditions are essential. Diversifying by testing this strategy on other currency pairs could also provide a broader safety net.

Additional comments

The strategy can be described as a combination of mean-reversion and buy-lows/sell-highs on retracements according to the recent trend direction. In simple words, when we see a strong uptrend, we buy on rebounds after the price could not break through various support levels marked by the Ichimoku indicator (Kijun-Sen, Tenkan lines and upper range of the cloud). The same approach was used during downtrends, although the vast majority of trades were buy GBP/JPY.

It’s worth stating weak points straight away. Maximum drawdown exceeded the average requirement for a low-risk trading strategy. That was reached only once when the indicator was showing uncertainty, and prices breached crucial support levels but failed to proceed with the counter-trend rebound. On the one hand, we had to switch to shorts as Ichimoku was showing some signs of a reversal. On the other hand, the general trend direction was upward, which could have been checked by simple switching to the daily timeframe to spot the setup. So, the drawdown could have been avoided. 

Next, we did not follow a straightforward requirement of the same lot size for all of the testing period. We doubled the lot size at some point, and even started using 3 lots per one trade, having up to two trades opened simultaneously. To achieve better results in the profit-to-loss ratio and the percentage of profitable deals, it’s worth keeping the balance at the initial level, withdrawing profits every month, and using only one trade per time with a 1.0 lot maximum. Such an approach would lead to lower drawdowns, less time under the water and more pips gained. However, profits in dollars could have decreased as well.  

We used default settings for stop-loss orders at 60 pips (four-digit quotes) and take-profit orders at 150 pips (four-digit quotes). Sometimes we used to place pending orders: buy-limit, buy-stop and sell-limit. They were placed according to Ichimoku support/resistance levels. 

The good news is that the return of 247% in 5 month, and the average monthly profit of 50% compared to the initial deposit, together with the maximum drawdown of 17% (from average balance), and average loss of 5.7% (of the initial balance) cover all of the weaknesses of the trading approach. The probability of profitable trade is 61%, which is lower than required. It would be good to have at least 80% to get the best ratio. Maximum loss of 12.8% from the initial deposit is too high. However, it occurred when the balance was doubled, so the percentage is actually lower. On the other hand, the ratio of Max Profit per trade to Max loss per trade is impressive (3:1 approximately), and again, it covers the weakness. 

6. Conclusion

The GBP/JPY trading strategy, anchored by the Ichimoku and RSI indicators, showcases promising potential. Its strong profitability metrics, combined with an understanding of its risks, make it a worthy contender for those looking to refine their forex trading arsenal. As always, strategies should be deployed with proper risk management in mind.

Disclaimer: It's important to note that past performance of any trading system, methodology, or particular trader is not indicative of future results. All investments come with inherent risks, and while the backtested results presented in this article offer insights into the strategy's historical efficacy, they do not guarantee future performance. Investors and traders should approach any strategy with caution, thorough understanding, and ideally seek advice from financial professionals before making decisions.