Adrian Reid explains backtesting: applying your trading rules to historical data to see when you'd buy and sell, and how much you'd make. He calls it critical for long-term success and pushes automated testing to measure your edge's durability, maximum drawdown, and losing streaks.
The first question is what is back testing in trading? And back testing, I would say, is the most critical skill that you can have if you're going to see succeed long term as a trader. Now why do I say that? It's because if you don't backtest, you're basically flying completely blind as to whether or not you've got an edge as to whether or not your strategy is working, whether you're going to make money or you're going to fall into ruin. Backtesting is essentially you take your rules and you apply them to historical market data and you see when you would have bought, when you would have sold, and you calculate how much money you would have made over time had you followed those rules exactly. And that's really important. Exactly right. Because when we're back testing, we're assuming that we follow those rules. We buy when they say buy, we sell when they say sell. And, and so my philosophy, my mantra, if you like, is to test what I trade and trade what I test. So I don't take a trade unless it's based on a proven set of rules that I've backtested and I've built confidence in so I can, I know that I can follow those rules and I'll be okay. This is probably the most critical thing because most people, like it or not, don't really know whether you've got an edge that is sustainable long term. Even if you're making money now in the current market conditions and you haven't back tested, do you really know what's going to happen in the next major bear market? Do you know how deep your drawdown could get? Do you know how many losses in a row you might have?
Do you know how many down days in a row? Do you know how long between equity highs? These sorts of questions are pretty much impossible to answer unless you've back tested your strategy thoroughly and backtested in an automated way using software.
