What is backtesting?

Backtesting your trading system can be a good idea to determine the strengths and weaknesses of your system. It is a very important tool you must use to create a working system.

This strategy is basically trading past stock movements in order to predict how your trading system will work in the future markets. This takes into consideration that history repeats itself, and the markets will behave in the future in the same predictable way they have always behaved. 

Critics of this strategy will say that “past performance does not guarantee future results”. Many people believe that the best way to test a trading system is to paper trade it in the actual market. That way it not only gives you a feel for how your system will work in today’s market, but it will also let you see how you will actually trade it.  

While paper trading might be a great way to test a system, all systems should be backtested. Unlike paper trading, backtesting gives you the opportunity to experience how your system will do in different market situations. 

It will help you get understanding of how your system will work during other market time periods. This way it can help you save a lot of money. Instead of trading a system that was working in the old market but not in the new market, you will already know ahead of time what to expect.

I have found that in order to tell whether your system will actually work well or not, it should be both backtested and paper traded.