Lesson 1 from backtesting: Effects of randomness

One of the most important things about backtesting is the effect of randomness on financial markets.

This shows that random amounts of financial and efficiency data exist in most markets.

Once you realize that a completely random trading strategy is capable of outperforming a popular strategy like buy-and-hold, you will tend to see investing in a new dimension.

In addition, backtesting also allows you to test strategies with purely random models to see if you can improve your strategy better. For example, you can add random elements to a trading strategy like exit signals, hold times, indicator parameters, or rating points ... Using randomness in this way can be useful to test your strategic tension and ensure that the strategy is solid across many different aspects.

Lesson 2 from backtesting: The size of an advantage

Sometimes, you will get an idea of a pretty decent trading strategy that works well when applied to a few different charts. However, without backtesting that strategy properly, you won't be able to know the key metrics that affect how you should trade or allocate capital.

By backtesting a strategy, you can see the size of the advantage, the winrate, the drawdown, and the expected return.

This information is important because it allows you to see if your profits are large enough to outweigh the trading costs (or slippage).

It also allows you to calculate the sequence of losses so you can decide if you are mentally enough to follow a system through bad stages.

Most importantly, these will show you what the payoff was in the past, and so you'll know if you should allocate capital to this strategy, along with how much capital it is. OK.

Further, once you have the above information, you can use backtesting to try out different capital management techniques, such as Kelly, fixed risk, Williams ...

Lesson 3 from backtesting: Answers to important questions

A classic example of the usefulness of backtesting is that it allows you to see relationships in the history of things.

For example, you may have heard that bonds are negatively correlated with stocks, or that gold is a hedge against inflation.

But how can you believe these "rumors" without going back in time and seeing if they are true?

With backtesting, you can look back in the past and see how certain correlations are maintained. And you can see how those relationships react under different market conditions.

More importantly, backtesting allows you to answer important portfolio questions like:
  • What is the optimal number of shares to hold in a portfolio?
  • How many strategies or areas do you need to include in your portfolio?
  • What is the optimal allocation mix?
  • Is there an optimal rebalancing period?
Without backtesting, answering these questions is like throwing darts into the dark!

Lesson 4 from backtesting: Skepticism and simplicity

Once you've been doing backtesting for a while, you'll begin to understand that many of the strategies people flatter are often not as good as the "rumors".

Backtesting will give you the power to test strategies and see if they are compatible with scientific analysis. As such, it creates the level of skepticism needed to keep you from falling victim to scams (or at least not being lured into by "fake" experts).

Over time, backtesting has also shown traders the importance of simplicity. Have you ever backtested hundreds of strategies just to find a strategy that was too complicated and difficult to implement in real trading? It is because of this that you realize that you can only make more money by following a simple strategy, but spend more effort and capital on it!

Lesson 5 from backtesting: Cultivate confidence in a simple framework

The most valuable thing about backtesting is that it gives me the ability to adhere to simple investment frameworks with more confidence.

When the market reverses, it's easy to give up a panic strategy, but backtesting is what reminds us that the most important thing in a time of panic is to stay the same and not jump in. worst time.

Confidence can be the most important quality for any trader and backtesting will help you find the confidence you need.

The truth about Backtesting

After all, backtesting isn't so perfect, and of course, it has issues to keep an eye on like consistent data and over-optimization habits.

However, when applied correctly, backtesting is an effective way for traders to answer questions and analyze the strength of a particular trading strategy. Backtesting can be used as a tool to tell you whether the truth behind a certain statement is right or wrong, so as a trader, do not ignore the backtesting stage!

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