Getting started
Hopefully, the lessons in this backtesting course help you succeed in building a portfolio of trading strategies.
To help you along the way, we end the course with what we consider the five most important aspects of backtesting and trading:
Be patient
Learning both backtesting and trading takes time. We are talking years. But the more time you put in, the better and faster you learn!
Focus on drawdowns….
When you backtest, have a look at the drawdowns and win rate. Why?
Drawdown is very important in trading because it makes a huge impact on your behavior and subsequently your returns. Even if you have a strategy that returns 50% annually you might abandon it along the way if you suffer a temporary setback in the form of a drawdown. In the midst of a drawdown, you don’t know if the strategy is busted or if it’s just temporary. In practice, all strategies stop working sooner or later.
What is an acceptable drawdown? Only you can tell, but obviously, you want it as low as possible. But this is a thin line. A small drawdown makes the backtest susceptible to curve fitting or randomness or is just something waiting to “blow up” (the calm before the storm).
On the other hand, drawdowns might be the reason why strategies can last for a long time. Drawdowns shake out the weak hands.
Our experience indicates that any drawdown bigger than 20-25% makes most traders shaky and uncertain. This results in abandonment, fiddling, or curve fitting. Thus, 25% can serve as a heuristic for max drawdown.
….and the win rate
A high win ratio is important because it reduces behavioral mistakes and the risk of ruin.
As you get more knowledge and experience, we are confident you’ll appreciate a high win ratio, even though your average winners might be smaller than your average losers.
Make a portfolio of strategies
Ideally, you’d want to have an “arsenal” of trading strategies. The reason is diversification and non-correlation. Please reread our lesson about correlation!
Trade small
We have a general trading rule: always trade smaller than you’d like to! This is the only way to reduce behavioral mistakes. Consistency is more important than trading big!