You’ve probably seen tons of people with pro or newbs or amateurs or even yourself, use this word in the past. TONS of signal providers, system/strategy creators probably use it as well and they all probably fail at life but that’s for later.
Definition (from investopedia): The process of testing a trading strategy on prior time periods. Instead of applying a strategy for the time period forward, which could take years, a trader can do a simulation of his or her trading strategy on relevant past data in order to gauge the its effectiveness.
The problem with backtesting is that you’re testing your strategy on something that has already happened. Whereas when you’re trading in real time, things are always changing. That’s why I don’t really believe in “systems” i.e. systematic decisions to help you make a decision. It’s not subjected to change, that’s the problem. Unless you have a strict strict system in play then I guess its ok. It’s hard regardless.
Charts in the past have already settled, crosses have happened, candles have closed etc. Let’s use an example, let’s say your strategy is like a big green candle + MACD crossing up or something when price is at the bottom of a range. In real time, this could form, but then when do you enter? Do you wait for the close or enter when you see it? If you see it, enter, what if it drops back down and closes red and the MACD didn’t cross.
Also, in hindsight, you see what you want to see i.e. you make a strategy based on something that already happened knowing what’s coming next. So it’s subjective, I guess? Like an illusion kind of.. Beacuse you design a strategy around reversals for example, then you look for all the reversals and see if the thing you want the system to be based on, happened or not, and more often than not, you just swing yourself into a position where you think it does all the time. This is hard for me to put in words right now, but just don’t let backtesting consume you/get to your head. You still need to test it live first.
Bottomline, sure, test out your strategy in hindsight backtesting. But, before you trade live with it, trade it on demo to try it in real time, then try it with small risk then when you’re sure it works, then you play it big.