Backtesting involves running a trading system through historical data to evaluate how it would have performed in the past.
Curve fitting is a process of tweaking parameters of the system to fit historical data perfectly. This means that the system is optimized for the past, but not for the future.
Curve fitting is like a bad ex.
You think it's the one, the perfect fit, until it turns out to be nothing but noise.
Although a curve fitted trading system may appear successful on paper and generate impressive backtest results, it is likely to fail when exposed to live trading conditions.
This is because a trading system tailored specifically to the historical data cannot adapt to market conditions.
Thus, relying solely on backtesting to evaluate the performance of such systems is misleading.
The more curve-fitting that has been done, the less likely the strategy is to perform well in the future.
The wise is listening to the market's talking instead of trying to force the data to fit preconceived notions
"If you torture the data long enough, it will confess to anything."
Mark Twain
There are several red flags that may indicate a curve fitted trading robot.
- The backtest period is too short or too specific.
- The backtest results are too smooth or too consistent. For example, if the system has no losing trades at all, then it may be curve fitted to avoid any losses.
- The backtest results are too good to be true. For example, if the system has a very high profit factor, a very high win rate, or a very low drawdown, then it may be curve fitted to exaggerate its performance.
While backtesting is an essential tool for evaluating trading strategies, it is vital to be cautious of curve fitting. Traders should aim for robust strategies for actual trading in live markets. Stick to the basics. Build a solid strategy based on sound principles and stick to it.
It's much easier to trade with the trend than to try and bend it to your will. And who knows, maybe one day you'll be able to curve-fit your way into a profitable trading strategy.
In the end, the only curve you should be worrying about is the learning curve.
You are welcome to check out our automated trading systems here.
