The Seduction of Back Testing

Back testing is as old as charting. However it is now the rage of your online discount broker, like it is the hosanna of trading. It is oh so seductive, putting in your trading ides that are probably fairly good, then you can see how they would have done the last x number of years. Then you can tweak it until you make unbelievable returns. And you then quit your job put all your money into your new system and look up villa on the south of France to retire to. Okay you might not go that far, but you get the gist.

The problem is the system did an unbelievable job of pinpointing profitable trades in the rear view mirror,like a Monday morning quarterback, anyone can be a genius in the rear view mirror. But the only thing you can really bank on, is your system will not perform that well, or even near that well going forward.

To be fair there might be a good trading theory in there and it might be something to trade off of, but don't bet your retirement on it. One thing about systems trading is they lose lots of money every now and then, and lately it has been more now and will be a lot less then because all of the trading capital is bye bye.

There is and never will be a machine that can play quarterback, nor is there one that can trade going forward like they could looking backward. And chances are if you put your system to work and lost everything the FED would not give you access to TARP funds.