Trade Ideas defines back testing as the use of historical data to help determine validity of trends. In back testing one takes past data and supposes that trades were made based on certain signals. Then one looks at the trades to see what would have happened in terms of positive or negative results. Back testing allows a trader to test theories before risking capital in real market conditions. One of the best analogies for back testing is in golf. Going to a driving range to work on your game is very similar to back testing a trading strategy. The important aspect of this analogy is understanding that just because something back tests very well does not guarantee that it will work out in real trading, however it does give you a good sense of what to expect and that is important for controlling risk while trading.
In Trade Ideas we take back testing to a slightly higher level by doing what we call “event based” back testing. Our software does not know what stocks you will be trading at the time you are back testing. Instead our software focuses on the event, such as a “10 day high on 5x volume,” and looks at every stock that had that event take place. Then the software simulates going long or short on that event depending on what you specify to give you an idea if the event is a tradable signal or just noise.