Q: What is your view on backtesting? Based on readings in the area, it seems to me that backtesting has limited use. It doesn’t tell you what works now or how you would react to the psychological issues. There are questions about data integrity and slippage. And whether you would really be able to execute the trades like the computer does. Would testing using small position size be the most effective?

Van's Response: A certain amount of backtesting is useful to help you prove or disprove theories. For example, if something doesn’t work in backtesting, then it probably won’t work in real trading. However, there are strong limitations to all of the software involved in backtesting. There are position sizing limitations. And as soon as you move into backtesting you must specifically define all your rules (which is good), but it also leaves no room for discretion. For example, I’ve never found a good rule for defining something going up in a straight line… whatever rule I use always gives me weird looking charts that I wouldn’t touch. Thus, I know what I want but getting a computer to find it is not easy. And those are just a few of the limitations. I talked about them in some detail in the new edition of Trade Your Way to Financial Freedom.