In today’s newsletter, I want to address the biggest mistake I see traders make when they start backtesting.
Backtesting is a superpower – the sooner you start backtesting the sooner you’ll start realizing the benefits.
Backtesting is a lot of work, but when done properly the payoff is immense.
The problem is most traders start backtesting in a way that still requires all that effort, but minimizes the actual benefits.
If you’re going to put in the effort, it’s important to do it in a way that will maximize the benefits, otherwise all your work will be wasted.
Most traders begin with an idea for a strategy they apply to a single symbol, usually a well-known market index like SPY or QQQ.
Creating a strategy that trades a single symbol like this can work, but it’s vastly inferior to a strategy designed to trade any stock.
When you backtest using a single symbol, you’re competing against every trader with the ability to simply look at a chart. That’s almost every trader on the planet.
But when you start with a strategy designed to trade any stock in the market, the pool of traders you’re competing against drops dramatically.
It’s a hard technical problem to create software that backtests all of the thousands of symbols that actively trade each day.
Creating software to backtest a single symbol is trivial in comparison.
That’s why you see so much software in the industry that claims to “backtest”, but only a small handful can tackle the more lucrative problem of backtesting the entire market.
Why is it so much better to create a strategy for the entire market? Lots of reasons:
- There are far more opportunities – it might take a decade to accumulate enough profitable trades in a single symbol to be worth trading
- More opportunities give you more flexibility to improve your strategy
- The types of strategies that work are easier to come by when applied to the entire market
- Because of the technical issues of scanning the entire market, your pool of competing traders is much smaller
- Easier to create a statistically valid strategy you can have confidence in
- Your strategies will have more “staying power” – that is, they’ll deteriorate less quickly
