The Value of Backtest

“The study of history lies at the foundation of all sound military conclusions and practice.” 
― Alfred Thayer Mahan, The Influence of Sea Power Upon History 1660-1783

If you are a commander of a modern warship, you probably have studied history and tactics of tall ships in a naval college. The purpose, obviously, is not for getting you prepared for a battle with tall ships and cannons. Instead, it’s to show you the evolution of sea warfare and build up your instincts as a sea wolf. From manpower and wind to nuclear power and steam, from muskets and cannon to CWIS and missiles, although the technology never stops changing, the importance of speed, timing, relative position, and fire power has been deciding the results of sea battles since the first time in history that two people fought in Canoes with their paddles.

Battle of Trafalgar – by Robert Taylor

Crossing the T Tactic used by Lord Nelson in Trafalgar

It’s a very good analogy for investors and backtests. A sound analyst should not get excited solely for good backtest results. He ought to know the reasons behind and what do they mean in real-time trading. An impressive backtests, in some cases, is probably not suitable for trading, but might be very valuable in terms of finding market behaviours and confirming insights in investments. If  possible, two equally good analysts living in different eras should draw the same conclusion through performing a backtest on Reuter’s carrier pigeons (read more) and modern HF trading.

On top of that, in order to fully utilize the value of backtest, I believe an analyst should be able to think in terms of arrays instead of separated numbers. The distribution of returns or drawdowns of a strategy usually contains more valuable information than its annualized return and volatility.

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