Last Updated on 15 January, 2025 by Abrahamtolle

When you have a nice-looking backtest, it’s easy to get excited about the potential results. However, live trading often introduces factors that can make actual performance differ significantly from what was shown in the backtest. Here are several key points to consider:

1. Execution Slippage

• Backtests typically assume perfect execution at the desired price. In real life, slippage can occur due to:
  • Market conditions (low liquidity, high volatility)
  • Order execution delays
  • Bid-ask spreads
• What to expect: Your fills might occur at slightly worse prices than in the backtest, which can erode your edge.

Here you can read more: Backtest vs Live Trading

2. Commissions and Fees

• Backtests often overlook or underestimate the true cost of commissions, fees, and taxes. These costs can add up, especially in high-frequency strategies.
• What to expect: Transaction costs can cut into profitability, especially if your strategy trades frequently.

3. Market Impact

• In the backtest, it’s assumed that your trades don’t impact the market. But in live trading, larger orders can move the market price, reducing your expected profit.
• What to expect: The larger your trade size relative to the market’s liquidity, the more your orders will impact the price.

4. Real-World Latency

• Delays between sending orders and receiving fills can introduce latency that doesn’t exist in backtesting. This latency can lead to missed trades or worse fills.
• What to expect: You might not get filled on the best opportunities, particularly in fast-moving markets.

5. Overfitting

• Backtests often fall into the trap of overfitting, where the strategy is optimized too closely to historical data. The result is great backtest results but poor real-world performance.
• What to expect: Live markets change, and over-optimized strategies may underperform when market conditions shift.

6. Psychological Factors

• Backtests don’t account for human emotions like fear and greed. In live trading, it’s harder to stick to a strategy when experiencing losing streaks, missed trades, or volatility.
• What to expect: The emotional toll can lead to second-guessing your system, leading to suboptimal execution of the strategy.

7. Market Regime Changes

• Markets are dynamic, and a backtest might reflect a market regime that no longer exists. Structural changes (e.g., economic conditions, interest rates, regulations) can cause strategies to stop working as well.
• What to expect: The strategy might need periodic adjustments to account for changing market dynamics.

8. Data Quality

• The quality of data used in your backtest is crucial. Missing or incorrect data can lead to unrealistic backtest results.
• What to expect: Live data might expose inaccuracies in your backtested assumptions, causing unexpected results.

9. Optimism Bias

• It’s easy to be unconsciously selective when choosing parameters that work well in a backtest. In live trading, you might discover that your strategy was simply tuned to historical data quirks.
• What to expect: Lower returns in live trading if the strategy was overly fine-tuned.

10. Position Sizing and Risk

• Many backtests use fixed position sizing without accounting for risk management factors like position scaling or portfolio drawdown.
• What to expect: Over-leveraging or ignoring risk in live trading can amplify losses, even if the backtest shows smooth returns.

In summary, a good backtest provides confidence, but live trading comes with a host of real-world factors that can alter results. The more robust and conservative your backtest assumptions (including costs, slippage, and market conditions), the closer live trading might reflect those results. Always remain vigilant and adaptable, as real markets often surprise even the best-prepared strategies.