Backtesting can be a very helpful way to get a stock market system made. It has been used effectively by traders for years.
So, what is backtesting? Well, it is simply using the past performance of certain stocks in order to see if your system will work in their future stock movements. If you were back testing a system you would be following your system rules in past stock movements and see where it gets you.
The idea of this is that history repeats itself. If your system worked in the past movements then it will probably work in the future. That does seem to make some sense after all.
It is considered to be very valuable, but it also does have its flaws. Even though it could tell you your system works it will not show you how it works in different market postures. It could be that it works very well during a bulls market but very poorly during a bears market. It could also be the opposite working well during bears markets but poorly during bulls markets.
Or it might leave you unprepared for such surprises like new events or bigger market news. It is for those reasons that many market professionals will tell you the famous quote “past performance does not guarantee future results”.
Because of that this should always be coupled with paper trading. Backtesting will give you a general idea of how your system worked in the past. Paper trading will help you determine how your system is working in the present market. It will also help you decide the best way to trade your system. What rules as far as risk management, or such, do you need to make your strategy work the best? Those are very important things to figure out.
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