Dear Friends,

We have been discussing on various approaches and strategies on the financial markets during trading and investments.

This is a common scenario for many who enter the trading world with big dreams.

You sit at TradingView, scroll back through historical charts, and test your strategy.

Everything seems perfect there. But that very perfection is the problem.

With the strategy you’ve devised, the market rises when a 'buy' signal appears and falls when a 'sell' signal appears.

By seeing this, you may feel a have a sort of confidence, thinking, "Wow... I’ve found an amazing strategy; I’m going to be the next millionaire."

However, the situation changes completely when you take that same strategy into the live market and put real money on the line. The strategy that yielded great results during the back-testing ends up wiping out your account in the live market.

Why does a strategy work perfectly in back-testing but go completely wrong in live trading? Why does this happen for us?

In this post, we will explore the underlying truths and key technical reasons behind this phenomenon.

1) When you do a back-test a strategy, you aren't risking at your own money.

Even if the strategy fails five times in a row, you simply move to the next chart with a mouse click during back-testing; your state of mind remains unaffected.

In contrast, in the live market, if you lose money on three consecutive trades using your hard-earned capital, your hand will tremble when placing a 'buy' order for the fourth trade—even if the signal is correct. That fear is never recorded in a back-testing report.

2) Changing the market conditions:

While doing the back-testing, you may have analyzed data from only a specific one-year period. During that year, the market might have moved steadily upward in a single direction only. But, when you step into the live market, the trend might have shifted to a sideways movement.

When the market's nature changes, a strategy built on historical data can completely backfire and result in losses.

3) News and sudden, unexpected shocks in the market:

You might see a large combination of red candle on a back-testing chart but simply gloss over it.

In the live market, however, a sudden event—like an US FED meeting or the release of a company's financial results at any time during the market hours and its expectation can cause the market to drop a hundred points in a split second.

At such moments, the market may completely disregard your SL order. To make matters worse, your system might hang or your internet connection could fail right then.

So we should understand that  back-testing alone cannot account for these real-world technical glitches or  the impact of news events at all times. 

4) The demon of over-trading: Back-testing might show only one or two signals per day.

You would naturally focus only on those. But in the live market, if you incur a loss at 9:45 AM, a desperate urge to recover that loss immediately might drive you to place consecutive trades on your own, even when there are no valid signals.

Back-testing may seem to teach you discipline, but the live market tests your patience and tempts you to over-trade. 5) A crucial factor involves "repainting" indicators: many indicators on TradingView adjust themselves based on historical data to present a visually appealing picture.

An indicator might display a "buy" signal in a live market, but if the market suddenly crashes, it simply erases that signal.
When you review the chart later, it appears perfectly accurate, as if the erroneous signal never existed. Relying on this for live trading leads only to disappointment.

Finally, there is the "hidden villain" in the form of brokerage fees and taxes. In backtesting profit calculations, we often overlook costs like brokerage, STT (Securities Transaction Tax), and GST. We tend to count a hundred rupees of profit as exactly that—a hundred rupees. However, in the live market, if you execute thirty trades over a month, these taxes and fees will consume a significant portion of your profits.

Often, a strategy that appears profitable during backtesting ends up resulting in a loss in the real market once taxes are deducted.

Beyond this, there are numerous other factors such as slippage, latency, liquidity issues, and spreads.

Does this mean one shouldn't backtest at all? Absolutely not; it is essential. Just as I mentioned in the previous post that indicators should serve merely as supporting tools, the same applies to back-testing.

Back-testing should be used solely to gain insight into an idea.

It helps you to understand how a strategy performed in the past.

However, to determine if it truly suits you, you need to conduct forward testing in the live market using a small amount of capital.

You can become a profitable trader only by directly facing your emotions and the actual pace of the market.