What is backtesting and how does it work?

Backtesting is a testing method that measures how well a strategy can perform using historical data through a simulation. By evaluating how well a strategy would have worked on a similar investment, investors can use that strategy with greater confidence in future investments.

What are the different types of backtesting measures?

Common backtesting measures include net profit/loss, return, risk-adjusted return, market exposure, and volatility. Analysts use backtesting as a way to test and compare various trading techniques without risking money. The theory is that if their strategy performed poorly in the past, it is unlikely to perform well in the future (and vice versa).

What is backtesting in predictive modeling?

Backtesting is a term used in modeling to refer to testing a predictive model on historical data. Backtesting is a type of retrodiction, and a special type of cross-validation applied to previous time period (s).

What is backtesting trading?

During backtesting trading strategies, you often tend to backtest a strategy on the current stock universe rather than the historical stock universe. That is, you use the universe that has survived until today to backtest. There is a famous example that is used to illustrate the survivorship bias.