Back testing is a trading strategy that involves the task of analyzing historical data related to the investment opportunity. The results of the investigation are then compared to the current status of the investment. This is to determine if there are any indications of favorable trends.

When you back test a theory, the results achieved are highly dependent on the movements of the tested period. Back testing a theory assumes that what happens in the past will happen in the future, and this assumption can cause potential risks for the strategy.

Back testing can provide plenty of valuable statistical feedback about a given system. Some universal backtesting statistics include:

• Net Profit or Loss - Net percentage gain or loss.
• Time frame - Past dates in which testing occurred.
• Universe - Stocks that were included in the backtest.
• Volatility measures - Maximum percentage upside and downside.
• Averages - Percentage average gain and average loss, average bars held.
• Exposure - Percentage of capital invested (or exposed to the market).
• Ratios - Wins-to-losses ratio.
• Annualized return - Percentage return over a year.
• Risk-adjusted return - Percentage return as a function of risk.

Back testing is one of the most important aspects of developing a trading system. If created and interpreted properly, it can help traders optimize and improve their strategies, find any technical or theoretical flaws, as well as gain confidence in their strategy before applying it to the real world markets