Back Testing at Mindful Trader

On this website, I talk a lot about all the stock market research I've done. That research was conducted largely by creating trading strategies (using an algorithmic coding approach) and testing how those strategies would have performed historically.

That's referred to as back testing. Although back testing can give us excellent insights about which trading strategies are profitable, it's important to understand that the results of the back tests may not be the same as what live trade results would have been. Since we didn't make these trades live, we really can't say definitively what exactly our entry and exit prices would have been.

There are market conditions that could have affected our ability to enter or exit the trades exactly as the back tests show. A sudden lack of liquidity is an example of such a condition. Another limitation of back tests is that they are performed with the benefit of hindsight. Yet another is that human error could affect the results.

Also, when it comes to the back testing of stock trades, there are some days in the back test where more than one stock trade could have been made. There is no way for me to know which exact stocks I would have traded. I limit myself to two trades per day, and in my back test I made an arbitrary assumption about which two trades those might have been.

Additionally, with options, I had to make assumptions about the amount of extrinsic value associated with each simulated option purchase in the back test. Since I didn't buy these options with live trades, I can't say definitively what the amount of extrinsic value would have been. (It should be noted, though, that I buy deep-in-the-money options so as to limit the amount of extrinsic value in each option.)

Therefore we have to take the results of the back tests with a grain of salt. I have worked hard to account for many potential discrepancies that could come up from back testing. You can see the approach I've taken with my research here.

Even so, there is no way for me and anyone to be certain that back tests accurately reflect what live results would have been since they weren't actual live trades.