Overfitting

Trader's Glossary · Process and risk

Definition. Fitting a method's rules to historical data so closely that they describe random noise instead of lasting relationships. Such a method usually fails on new data.

How it works

The more parameters and conditions you add to improve the historical result, the greater the risk that the method has “learned” random cases. The backtest looks great, live results look poor.

Example

A method with a dozen filters achieves an excellent result on one year's data and loses money the following year.

What to watch out for

What helps: simple rules, testing on data that wasn't used to build the method, and a reasonable number of observations.

More in Hetman Capital Club

You'll find the full explanation with graphics, examples and exercises in the 🖥️ Order flow atlas space, and its use in the live market in the 🔴 Live Room. Both are available to Club members (in Polish).

Educational content, not investment advice.

Full article in the Atlas of biases: what this bias looks like in trading, an example and the research.