Backtesting - Financial definition
Concise definition of the term backtesting
Backtesting in finance involves testing a trading strategy or model using historical data to evaluate its potential effectiveness and profitability before applying it in live markets.
Comprehensive definition of the term backtesting
Backtesting is a critical step in the development and validation of trading strategies, allowing traders and financial analysts to assess how a strategy would have performed based on past market conditions. This process helps in identifying potential strengths and weaknesses, refining parameters, and avoiding costly mistakes in real trading.
For example, a quantitative trader might backtest an algorithmic strategy using years of historical price data to gauge its performance metrics, such as returns, volatility, and drawdown, thereby providing insights into how the strategy might behave under various market scenarios.