What You Need To Know About Backtesting A Strategy
- npatel81
- Sep 5, 2014
- 1 min read
More and more investors are using simulations on the past (or backtests) to make investment decisions for the future. Unfortunately they often make two mistakes: they assume that a simulation has a predictive power and they focus on the return. Whereas the main interest of a simulation is in evaluating the risk of a strategy. Here are some non-exhaustive ideas about how avoiding the pitfalls and how interpreting a backtest.
A. The 7 Deadly Sins of Backtesting
1. Forgetting time factors
A simulation should use only data that were available at every decision point in the past. Make sure that your database has no bias by design. It must contain disappeared and merged companies. Index-based universes must be timestamped (for example the S&P 500 list changes over time). The fundamental data must be timestamped and available at each point in time.
2. Forgetting trading costs and slippage
Even with a
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