What is overfitting?

1. "Buy when RSI is below 27.5, only on Tuesdays, only when volume is between 1.3x and 1.45x its average."
2. Tuned on one period, a rule like this can show excellent results.
3. There's no reason those exact values should matter, so the edge usually disappears in the next period.

• Warning signs. Many conditions, very precise settings, few trades, and results that collapse when a setting changes slightly.
• Keep rules simple. Fewer, broader conditions are more likely to capture a real pattern.
• Test on unseen data. Design rules on one period, then check them on a period you didn't use to build them.

Related terms

• Backtesting →Backtesting is testing a trading strategy's rules on historical market data to estimate how the strategy would have performed in the past.
• Net Return →Net return is the total percentage gain or loss of a strategy or investment over a period, measured from its starting value to its ending value.
• Mean Reversion →Mean reversion is the idea that a price that moves far from its average tends to move back toward that average over time.