The Downside of Backtesting

Boris Schlossberg

I know. I know. How could I possibly disparage backtesting? After all every algo driven quant fund in the world – the new masters of the universe – runs all of their strategies through rigorous backtesting.istock_000024224001xsmall

Let’s put those guys aside for moment, because first, they have more computing power that the Pentagon and second 90% of their “edge” has nothing to do with trading and everything to do with cheating as it is essentially a programmatic form of front running.

Most of the quant world reminds me of an old Sylvester Stallone movie called Shade in which he plays a card shark.

The best part of that movie is the tagline – “When betting is your life- leave nothing to chance.”  The movie is basically about very sophisticated forms of cheating which is what a lot of quant trading is all about.

But us mere mortal retail traders must operate in the world of risk and when it comes to retail trading let me ask you a question – have you ever seen a backtest that was confirmed in real life trading?

I have seen plenty of beautiful 45-degree equity curves that turned to mush once real money was put on the line. I have seen many, sophisticated backtest results that were put through more data torture exercises than I could possibly imagine and yet they too lost their “robustness” within months of going live.

Master the Basics of Currency Trading

Our new online currency trading course is now LIVE!  Now you can master the basics of currency trading in 5 easy lessons.

You’ll discover…

  • How the currency market works:  A basic primer and description of the world’s 8 major currencies and how to trade them—simply and easily
  • How currencies can make you BIG money whether the stock market is rising or falling
  • How to speak the currency trader’s “language” to master all the terminology you’ll need to succeed
  • How to successfully invest in currencies using plain English “Buy” and “Sell” signals that are so easy to read and understand, a child could follow them

And much, much more.

PLUS, you also get lifetime access to the videos and course materials including workbooks and transcripts for all 5 modules!

Click here to learn more.

Instead of focusing on backtests let’s look at how one of the most successful companies in the world does business. In a recent article on Amazon, here is what it said, “But Amazon doesn’t spend too much time on internal testing.

ca_dd_btdm“They prioritize launching early over everything else,” one engineer wrote in an epic 2011 rant comparing Amazon’s culture to other technology companies.

Launching early with what Ries has dubbed a “minimum viable product” allows Amazon to learn as quickly as possible whether an idea that sounds good on paper is actually a good idea in the real world.”

This is an incredibly valuable lesson for us all. “Real Life” or in our case “The FX Market” will be the true test of our ideas. In fact, over the past three years I am proud to say that aside from a 20 or so manual samples on a chart, I have never backtested any of my strategies.

In fact, much to my amusement, every year traders with far more computer skill than I email me very elegant charts showing me exactly why my strategies are horrible losers – and yet in real life we haven’t had a down year on day trades since we started in 2013 and as shown last week I closed my personal account in 2016 with 21% gain.

Why do my strategies lose in theory but win in practice?

Because I don’t care about theory, I only focus on practice. Trading is 90% tactics and 10% strategy. People who like to backtest everything have those numbers in reverse, which is why much to their consternation they inevitably lose. They spend too much time thinking and too little doing.corporate_finance2

I would even go so far as to say that I despise backtesting because it mainly offers false hope and breeds intellectual arrogance that forces the trader to make the same stubborn mistakes over and over again.

To trade well – take a lesson from Jeff Bezos. Prototype and then put it out into the real world. Let the market be your teacher. That’s the only test that matters.

Until next time,

Boris Schlossberg

Mr. Schlossberg is  the managing partner at BKForex  and creator of the new course The ULTIMATE Forex Trading Course produced in conjunction with Weiss Educational Services. He is also a weekly contributor to CNBC’s Squawk Box and a regular commentator for CNBC Asia and CNBC Europe. His daily currency research is quoted by Reuters, Dow Jones, Bloomberg and Agence France Presse newswires and appears in numerous business publications and newspapers worldwide. Mr. Schlossberg has written articles on trading for SFO magazine, Active Trader and Technical Analysis of Stocks and Commodities. He is the author of Technical Analysis of the Currency Market and Millionaire Traders: How Everyday People Beat Wall Street at its Own Game, both of which are published by Wiley. Boris’ extensive experience in trading and developing momentum based techniques provide the foundation for BKForex strategies.