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The Four Most Common Errors In Backtesting

Although backtesting is an essential part of the strategy development cycle, traders must be careful not to fall into one of the common errors or biases that may happen while backtesting. Here is a short list of some of the most common ones:

Data quality - Make sure that the data feed you are using is coming from a quality source. Low quality or incorrect data may not reflect how your strategy would have done during that time period. If you are backtesting in a platform designed for automated strategies you should be fine, but if you are testing the strategies on your own be very selective in the data provider you choose.

Survivorship bias - Some strategies may be prone to survivorship bias. This can happen if your strategy is based on an index of companies that may not have been included in the index during the time period your backtest. Using ETFs is one way to eliminate survivorship bias because the composition of the ETF changes to track the index.

Look-Ahead bias - The Look-Ahead bias or Postdictive Error happens when you use information in your strategy that would only have been available after the time period you backtest. The classic example of look-ahead bias is a backtested trade that was based on earnings figures that were not available during the time period you backtested.

Semantic Errors - This type of error is very serious and can happen to any trader if they are not careful. Semantic or logic errors occur when you are designing your strategy and you mistakenly set a parameter to something you did not intend to use. An example of this would be, using a different interval or setting an operator to "less than" when you intended to have it set to "greater than." To prevent this type of error be careful when designing your strategy, and make sure you double check it from top to bottom before you run a backtest.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.