A time series is considered stationary if its probability distribution does not change over time. If the price series of a security is stationary, then it would be a suitable candidate for a mean-reversion trading strategy. However, most security price series are not stationary: they seem to follow a lognormal random walk; and drift farther and farther away from the initial value.
Backtesting A Trading Strategy Part 3
Backtesting is a tool to measure the performance of a trading strategy using historical data. The backtesting process consists of three parts: 1. determining the universe of securities where we will invest in (e.g. equity or fixed income? US or emerging markets?); 2. gathering historical data for the universe of securities; and 3. implementing a trading strategy using the historical data collected.