Article Backtesting and Data Mining

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IntroductionIn this article we’ll take a look at two related practices that are widely used by traders called Backtesting and Data Mining. These are techniques that are powerful and valuable if we use them correctly, however traders often misuse them. Therefore, we’ll also explore two common pitfalls of these techniques, known as the multiple hypothesis problem and overfitting and how to overcome these pitfalls.
BacktestingBacktesting is just the process of using historical data to test the performance of some trading strategy. Backtesting generally starts with a strategy that we would like to test, for instance buying GBP/USD when it crosses above the 20-day moving average and selling when it crosses below that average. Now we could test that strategy by watching what the market does going forward, but that would take a long time. This is why we use historical data that is already available.
"But wait, wait!" I hear you say. "Couldn’t you cheat or at least be biased...
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