Still a beginner here. Back testing must have some validity. I've seen in a few places that strategies that work great in backtesting then fail in real trading. I don't see why, the investing universe can't have gone through a wormhole just when you went live. But anyway, how do you know if your successfully backtested strategy is going to work in real time?
Short answer...by forward testing, with real money. I've never found a back test that adequately models my irrationality, stupidity, or greed (or for that matter, that doesn't assume I'm omnipresent). That said, I know there's plenty of people here who back test successfully, so they may have more useful insight.
if it's was pure mechanical strategy that fails in real life while successful in back-testing then there was a mistake somewhere.... most often it was just curve fitting not the successful strategy if its not a mechanical strategy but the strategy that requires involvement, decision making by the trader then you probably lied to yourself somewhere in back-testing, you assumed somewhere that you would... but in reality you find that you just can not what is a method? - it's just a set of rules based on found laws of the market... assuming one finds all the pertinent laws and defined all the required rules based on them, what usually happens: the wannabe trader forgets to establish the set of overriding rules so the bottom line: back-testing does have some validity, but just some... also, do not forget that u just back-tested the method, not yourself...
It does go through a wormhole. When real money is on the line, one's emotional state can and frequently overwhelms the rational thinking process. This generally results in the selective use of or the violation of the "rules" one has developed in "owning their own system". There's a philosophical divergence when it comes to the various domains of strategies. The largest one's are that which exclude volume and those that include it. The one's that exclude volume are the most prevalent. Discernment increases as a skill the quicker one can verify one's hypothesis as "is true" or "is false." All in all, my trading proficiency increases whenever I gain awareness of a larger context that illustrates why something I once believed to be true in all situations is true only in certain defined ones. A trader has a very different mental outlook than an investor. Aside from the timeframe one selects to trade, a successful trader seeks to cultivate a neutral bias of partnered observation with the market. The market is always right, always streaming information. How one goes about discerning reliable signals of change amid all that information is the crux. Noise for someone, is a signal for another and the opposite is true.
IMO: Many smart people are developing strategies to locate, then exploit "opportunities" (or edges) in the market. This process, by its nature morphs the market, by increasing competition on exploiting those cases until the "edge" dissipates. To remain profitable, strategies will need to morph with the changing market. Backtesting is good, and in my opinion, a prerequisite; but once an opportunity is found, it will eventually loose it's edge, so continued testing (forward and back) is needed to remain current.
Nothing in trading is linear or simple; If you enter this world thinking otherwise, that you will make a killing with your so-called Holy Grail backtested system...you may be in for a rude awakening. Each new trading day, the DNA of the chart or market behavior, is truly unique , Also throw in the wildcard factors of human emotion, miscalculation, greed, etc etc that you mentioned...and you have one hell of a complex, weird shit storm tornado on your little trading hands to deal with, That's why basically 99% of people fail in this game -- It's inevitable that you will step on a land mine, or die a slow cancerous death. I like the idea fellow posters said...to use Real money. Real money...is real. When things are real...it's well...real. and Real is so much different then fake or theory only. It's like The Matrix movie...do you continue to live in theory, backtesting, dream land -- Or do you choose reality... I love the world of trading -- it will make a man out of you real fast, Make you respect and appreciate life and decisions and wisdom and open-mindedness,
Backtest -----> Simulator Trading -----> Small Account Real Money Trading -----> Normal Account Real Money Trading Start over again whenver you make changes to your trade method or whenever market conditions changes (markets usually changes several times per year). The latter is one of the major reasons why many have drawdowns or consistent losses...they don't know how to change (adapt) their trade methods. Thus, they keep using the same trade method (without adapting the method) in market conditions not suitable for trading via their trade methods. Therefore, reality, all of us should be doing the above summary steps every year...several times per year.
You will know when you start to see the equity curve of your live trading account slope up with minor dips along the way. fan27
If you're not optimizing parameters or rules for your strategy, then just a backtest might be okay if it looks good based on your original hypothesis. If you are optimizing parameters, then you should do some out-of-sample testing. Walk-forward testing is great if you have enough data. Even with the best strategy though, market conditions could change and make it unprofitable.
%% Fan27 got the trend of it. Sure does have some validity; ''why failure??'' Several reasons ;its not about prediction; markets change. Slippage happens, commissions happen ......+ repeating pattern= markets change. 2 wheels ; wisdom is profitable to direct.BUT good thing ''the market is NOT random also'' I did much , much worse than random my first year--LOL-LOL