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Last Thursday I wrote an article on financial jargon only to notice that I had used what could be considered jargon only a couple of days before in my article about The Ivy Portfolio. I explained that Mebane Faber’s investment strategy had been back tested from 1900 to 2008.
Back testing occurs when someone looks back to see how an investment or trading strategy would have performed over a time period prior to the strategy actually being designed and implemented. In other words if a strategy was implemented in March 2008 and it performed very well from May 2008 until March 2009 that is not a very long time to determine how it would perform over longer time periods and over different types of markets. A technician can actually look back and see how the strategy would have performed if it had been utilized over a longer time period. Back testing is not 100% accurate and some systems can be more reliably back tested than others but it gives a good indication of a trading strategy’s likely performance over a longer time period. Be aware that back testing performance rather than actual performance is frequently used in marketing material.