A friend of mine emailed this set of tips for backtesting which I want to share with the group:
The value of backtesting is well known among veteran traders and is still the most highly recommended way of trying out a new system.
In order to make the backtesting process more effective, here are a few simple guidelines to follow:
(1)Ensure that the data you are using is, in fact, accurate and valid. They must check as well if this is the actual period they wanted to test.
(2)Given the large scale changes in the world economies, any historical data you use must be viewed in the light of these changed. The question of relevance is a an important one which can only be answered by the trader using the data.
(3)The range of your historical data should be enough to make a reasonable evaluation. Too short a time period may hide some undesirable system behavior.
(4)Wherever possible, backtesting software should be used in order to save time and minimize errors. There are some free alternatives already so cost is no longer an issue.
(5)Along with the backtesting strategy, the traders must utilize capital management as well in order to properly allocate their resources.
(6)Since most traders are advised to pick just one currency pair, it is important to make sure that the backtesting period selected is significant for that pair.
(7)Any data models that are utilized must include some allowance for slippage since it is a reality in today's market.
(Backtesting results must always be evaluated realistically in the sense that history in this case, does not necessarily repeat itself.
Backtesting should never be considered to be a 100% accurate evaluation. Aside from the capricious behavior of the market, the current condition today are quite unprecedented in many ways. The primary value of backtesting lies solely in its ability to provide the trader with an idea about the baseline behavior of his chosen system. It can show the responsiveness of the system to certain conditions, but everything beyond that are results that any prudent trader will evaluate with a grain of salt.
