In finance, backtesting looks at the viability of a trading strategy by testing how it would have done based on historical data. In other words, it uses past data to see how a strategy would have performed. If backtesting shows good results, traders or investors may go ahead and apply the strategy to a live environment.
But what do good results mean in this case? Well, the purpose of a backtesting tool is to analyze the risks and potential profitability of a particular strategy. The investment strategy can be optimized and enhanced based on statistical feedback to maximize the potential results. A well-conducted backtest can also provide assurance that the strategy is at least viable when implemented in a real trading environment.
On a more professional level, backtesting trading strategies is absolutely essential, especially when it comes to algorithmic trading strategies (i.e., automated trading).