The process of testing a trading strategy, risk model, or investment approach using historical data to evaluate how it would have performed in the past. This helps assess the viability and robustness of financial models before applying them to real markets.
Compound of 'back' from Old English 'bæc' and 'testing,' literally meaning 'testing backwards in time.' The practice emerged in the 1980s with increased computing power and electronic data availability, allowing systematic evaluation of investment strategies.
Backtesting is like having a time machine for your investment strategies - you can see exactly how your brilliant idea would have performed during the dot-com crash or 2008 crisis! The catch is that past performance doesn't guarantee future results, and there's always the risk of 'overfitting' - making your strategy look great on historical data but useless going forward.
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