Avoid This Huge Mistake When Backtesting

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
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