Backtesting is the process of testing prior time periods for a trading strategy. Instead of applying a strategy for the period ahead that could take years, a trader can do a simulation of his or her trading strategy on relevant past data to gauge his or her efficacy. When you backtest a theory, the results obtained are highly dependent on the moves of the period tested. Backtesting a theory assumes the future will be what happens in the past.
While most of it is performed using machines, you can execute it on a list of monthly or yearly data manually. It is a simple and straightforward approach which makes it very popular as an exciting and safe tool in the eternal search for the perfect forex strategy in the trader community. Traders who use this approach to test their trading plans hold to the assumption that what succeeds in the past will work for the future as well.
The most common testing technique among technical traders is backtesting of technical methods in light of past values. A basic principle of technical analysis is that price patterns reproduce themselves. By taking this theory to mean that a trading strategy’s past performance will guarantee or at least support its returns in future markets, backtesting aims at weeding out the less efficient resources and screening out the most successful strategy to be used in trading. But while it is common, the unpredictable, and continuously shifting nature of the markets makes backtesting a questionable method.
Not only does the quote change but also the laws that describe the quote change, meaning that a procedure that is valid today may not be so effective after a short period has passed. When we backtest a technique, what we test is its success in situations that might never be replicated again. Of course, there are still circles, pennants, breakouts, but the exact arrangement of one of these shapes is sufficiently different to invalidate the validity of previous trading choices in each and every other event.
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