Deciding Whether You Can Rely On A Backtest

After you've done a backtest and seen the results, how can you determine whether you can rely on those results or not?

Or maybe you might be thinking now, if the results say it made a lot of profit, then why shouldn't you be able to rely on those results?

Firstly, as per the "Managing Risk" article, the next step from backtesting is auto-trading in a demo account. So no real money will be risked, and it won't matter so much if you've made a judgement to use a system based on unreliable information.
 

Unreliable Information?

I used the word "unreliable" there, but perhaps "incomplete" is more appropriate.

What I mean is, just like a survey, you need a decent sample before you can go making conclusions. If 1 person says that they are going to vote for the conservative party, yes, that is a 100% vote for that party. And yes, if the next person is not going to vote for them, now it's 50-50. But if you want to expand the results from asking 2 people to be the expected results for an entire country of people, you just can't do it. And it's the same with backtesting.

If your backtest results show just 2 trades, they might well both be winners. That doesn't mean you should jump to trading real money with that system though. Even a system that wins just 20% of the time needs to have 2 winners out of 10 at some stage. Maybe your backtest just picked up those 2 winning trades.

The question is then, how many trades do you need for a decent sample size? And that's part science / part art. Because there's no definite answer. You just have to use your best judgement. And remember to auto-trade your system in a demo account before risking real money.