Backtesting is the process of checking a trading strategy by applying the strategy to historical price data to generate hypothetical trades, then analyzing the results to assess the performance of the trading strategy.

The backtesting engine is the most glorified piece of the operation however it would not be successful without clean data, objective trading strateiges, statiscally sound analysis, and someone to do perform all the tests.

Although most traders concur that backtesting is useful, many traders don’t do it because of the time, expense, and expertise required.    

Backtesting provides a model of trading.   Significant differences with live trading exist such as: commissions, slippage or skid, after hours trading, dirty data, software bugs, human error.  Backtesting results don’t guarantee future performance.    

Backtesting is a screening tool that is really good at eliminating under-performing trading strategies.   If a trading strategy didn’t perform well in the past, it’s unlikely to make money in the future.     

If a set of rules does perform well in backtesting - that’s great but not the end of the game.  Traders ultimately must decide if a given strategy is suitable for their own use.

Last updated 11/11/08.

Tags: backtesting, data, skid, slippage, trading

When using a market order, the price is not agreed in advance. An order, even a small one but especially large ones, might move the market and be executed at a surprising price!   The difference between the price quote and the price paid is known as Slippage in the stock trading world and skid among commodity traders.  Most backtesting engines allow the user to make an assumption of how much slippage effects each trade.

Extra Insight:

For my backtesting, I assumed zero slippage.  This is not realistic for market orders but is realistic for limit orders.

Using limit orders in live trading is one way to reduce the cost of slippage.    Trading less frequently is another.

(Backtesting Blog is an Amazon Associate.)

Updated 11/13/08.

Tags: backtesting, limit order, market order, skid, slippage, trading