Backtest
Applying a set of rules to historical data to see how it would have behaved. Useful for understanding a strategy, never a forecast of the future.
Also called: back-test, backtesting
A backtest runs a set of rules over past data to study how a strategy would have behaved: its returns, its drawdowns, how it held up across different market regimes. It is a way to understand a rule's character, not evidence that it will work ahead.
Backtests are easy to flatter by tuning on the same data, ignoring costs, or choosing a lucky window. An honest backtest models realistic costs and assumes the future will differ. Past behaviour informs a decision; it never settles it.
Related terms
- Systematic investingInvesting by explicit, pre-defined rules rather than discretion or gut feel, so decisions are repeatable, testable, and free of in-the-moment emotion.
- DrawdownThe decline from an investment's most recent peak to its subsequent trough, in percent. It is a direct measure of pain endured, and of the gain needed to recover.
- BenchmarkA reference index against which a portfolio's return and risk are measured, the yardstick that says whether a result is good in context.
Read it in context
- A strategy is a decision method, not a predictionA prediction says what will happen. A decision method says what you do, under stated conditions, whatever happens. The difference shows up at the only moment that matters: when you have to act and the outcome is still unknown.
- What a drawdown isA drawdown is the fall from a previous high down to the low that follows it, measured as a percentage. A second measure is its duration: the time spent below that high before it is regained. The two are read together to understand what holding the investment involved.
- What tactical asset allocation isTactical asset allocation, or TAA, adjusts how much of a portfolio sits in each broad category as conditions change, rather than holding fixed proportions through everything. Those shifts may be judged by a person or decided by written rules, but they move between whole categories, never between individual companies.