Backtesting involves analyzing historical data to determine favorable trends in current investments. It relies on simulations of past performance to predict future trading cycles. The reliability of results depends on accurate and complete historical data. Backtesting requires time and attention to detail but can ensure sound investments.
Back testing is a trading strategy that involves analyzing historical data related to the investment opportunity. The survey results are then compared with the current state of the investment. This is to determine if there are any indications of favorable trends. Below is some information on how backtesting works, why it is important to work with accurate data, and what can happen if backtesting is conducted improperly.
One of the key things to understand about backtesting is that the process relies heavily on running simulations. While it’s not unusual for any investment to be run through a series of simulations based on the number of shares bought or sold, the concept goes a little deeper with back-testing. Not only are simulations run based on the current state of the stock or the performance of the stock; simulations on the past performance of the investment are also carried out. This extra mile of predicting trading cycles and performance levels based on past status is then applied to the current investment status.
The purpose of the backtesting is to see if there have been a similar set of circumstances in the past that applied to the current state of the investment. If so, this could be a strong indicator of where the investment is likely to move in the future. This is especially true if the combination of past data and simulations indicates that the investment has been in a similar state on several occasions in the past and tended to move in a particular direction in most of the simulations.
One of the dangers of conducting backtesting is that the reliability of the results is directly related to the quality of the historical data used to run the trading simulations. Incorrect or incomplete data will quickly render any backtesting efforts useless. Furthermore, it is important not to overlook any aspect of the investment’s past performance, even if the detail may seem innocuous. The more complete and detailed the data used to conduct the backtesting, the greater the chances that the simulations will indicate a workable conclusion about how the investment will trade in the future.
Backtesting is not an exercise that can be done in five minutes or less. Also, the amount of detail that needs to be applied can be large. For folks who want a quick answer and aren’t interested in wading through past performance level documentation, backtesting can seem like a big deal for minimal return. However, in the case of a major investment, taking the time to backtest it is one way to ensure that the investment is sound and will grow in the future.
Smart Asset.
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