Backtesting Basics and Its Limits
The meaning
Backtesting means applying a set of rules to past market data to see how they would have behaved. It is a way to learn and to find weak points in a plan before risking money.
A simple way to do it
Write the rules first, then test them on a long period that includes rising, falling and sideways markets. Count every trade, include costs, and note the worst losing streak, not just the average.
Common mistakes
Changing the rules again and again until the past looks good is called over-fitting. It makes a plan look strong on paper and weak in real life. Testing on too few trades is another common mistake.
The main limit
The past is not the future. A test can show that a plan was reasonable, but it cannot promise it will work next month. Treat results as learning, not proof.
Key points
- Backtesting applies rules to past data.
- Include costs and look at the worst period.
- Do not keep changing rules to fit the past.
- Past results do not guarantee future results.
Trading involves risk. This article is for education and information only. It is not investment advice, and no course or method promises a return or removes the risk of loss.