Backtesting: What Is It Good For? [Part One]

Backtesting can be a useful to test new strategies, but it should always be approached with a certain degree of caution.

Indeed, a strategy backtested and adjusted in such a way that it produced the best results over a given period, say the previous five years, can more often than not be highly misleading. The conditions that prevailed over the past five years may never be repeated, and the benefit of hindsight allows the builder of the backtest to adjust the strategy being tested to produce perfect results.

And many backtests fail to encompass enough information to arrive at a suitable, reliable conclusions. Long Term Capital Management is a prime example and the recent Swiss Franc trading debacle highlighted how,...