Trading Glossary

Walk-forward optimization is a way to search for strategy parameters not on a single stretch of history, but across several sequential train/test windows: parameters are tuned on a "training" segment and immediately checked on the next, previously unseen segment.

Out-of-sample (OOS) testing splits historical data into two parts: a training part (in-sample), where the strategy's parameters are tuned, and a validation part (out-of-sample) — a separate stretch that took no part in the tuning, where the real result is checked.

Monte Carlo simulation in a backtest runs thousands of simulations in which the order of a strategy's historical trades is randomly shuffled, to show the range of possible outcomes rather than the single "lucky" path that actually happened in history.

MAE (Maximum Adverse Excursion) is how far price moved against an open position before the trade closed; MFE (Maximum Favorable Excursion) is how far price moved in favor of the position over the same time. Both are computed per individual trade.

A backtest runs a trading strategy against an instrument's historical data to see how it would have performed in the past, before using it on a live or demo account.

Overfitting is when a strategy's parameters are tuned so precisely to one specific stretch of historical data that they capture that stretch's random quirks rather than a durable market pattern.

The Sharpe ratio is a risk-adjusted return metric: the ratio of a strategy's average excess return to its volatility (standard deviation). The higher the value, the more return the strategy delivers per unit of risk taken.

The Sortino ratio is a risk-adjusted return metric similar to the Sharpe ratio, but its denominator counts only downside volatility, not the spread of returns in both directions.

Maximum drawdown is a strategy's deepest drop in equity from a local high (a "peak") to the following low (a "trough") over the period under review, usually expressed as a percentage.

Win rate is the share of profitable trades among all of a strategy's closed trades. A value of 60% means 6 out of 10 trades closed in profit.

The risk/reward ratio (R:R) is the ratio of the distance from entry to the stop-loss (risk) to the distance from entry to the take-profit (potential reward) for a single trade.

Position sizing is the rule for computing a specific trade's size: how much capital to commit on a given entry, independent of the entry and exit rules themselves.

A trailing stop is a dynamic stop-loss that automatically follows price in the trade's favor but never moves back the other way — unlike a fixed stop-loss set once at entry.

Slippage is the difference between the price at which a trade was expected to execute and the price at which it was actually filled.