Backtesting is a technique that allows traders to simulate their trading strategy using historical or past data to generate results and analyze risks, profits before actually risking any capital.
In other words, backtesting is a process where trading strategy is simulated by the trader using historical data to analyze the trend, profits, and losses before investing any actual capital.
A fundamentally sound backtest technique which yields positive results ensure traders to implement it in the actual world. Whereas, if it yields suboptimal results then it means that it needs some alters or rejection of the strategy. Even complicated trading strategies implemented by automated systems rely heavily on backtesting to prove their worth and effectiveness.
Where Backtesting can be Applied?
Well, as long as the trading idea’s that can be quantified, backtesting can be applied. Some huge traders or investors seek qualified programmer experts to develop the idea into more of a testable form. Basically coding the idea into the language hosted by trading platforms, enables traders to “tweak” the system by incorporating user-defined input variables. An example of this is the Simple Moving Average crossover system. The trader can change the length of the two moving average via. backtesting to determine which period of moving average would have performed best based on historical data.