What is Backtesting?
Backtesting is the process of testing a trading strategy against historical price data to evaluate how it would have performed in the past, helping traders assess potential profitability before risking real money.
Backtesting Explained
Backtesting applies your strategy's rules mechanically to past data. A strategy that performs well in backtesting has a better chance of working in live trading, though past performance doesn't guarantee future results. The main pitfalls are overfitting (optimizing for past data that won't repeat) and survivorship bias (only testing on stocks that still exist).
Real-World Example
You backtest a moving average crossover strategy on 10 years of AAPL data. Results show 200 trades with a 45% win rate, average winner $450, average loser $180. The positive expectancy ($202.50 per trade) suggests the strategy has an edge worth testing in live markets.
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