The Historical Simulation
We defined the term simulation in Chapter 2: The Systematic Trading Edge as a computer model of the trading performance of a trading strategy. The only price data available, of course, for a simulation are historical or past price data.
As was also noted therein, there can be a great deal of different information produced by a historical simulation. This information ranges from detailed information at the trade-by-trade level up to performance data, which summarizes an array of statistical data. Also, if the strategy were optimized, there is a body of data regarding this as well. Finally, if a Walk-Forward Analysis was performed, there are still more data resulting from this more complex process. Examples of all of these different reports and output will each be presented and explained in the respective chapters dedicated to these processes.
In this chapter, we focus on one of the most important, yet often neglected, aspects of the entire trading strategy development process: the accuracy of the historical simulation.
The information produced by a historical simulation is at the very foundation of our acceptance or rejection of the validity of the trading strategy. Beyond the simulation itself, of course, the evaluation of the optimization and the evaluation of the likelihood of real-time profit are also pivotal.
These results, however, are all built upon the simulation. If the historical simulation is inaccurate or flawed by design, consequently, ...