Comprehensive Guide to Strategy Backtesting on Mr. Market NEPSE
1. Strategy Backtest Overview
Strategy backtesting is a technique used in financial trading to evaluate the effectiveness of a trading strategy by applying it to historical market data. It helps traders and investors estimate potential profits, losses, and risks before deploying the strategy in live markets.
2. Core Components of a Strategy Backtest
2.1 Symbol
- Definition: Represents the stock on which the strategy is tested.
2.2 Strategy Used
- Definition: Defines the specific trading strategy applied.
- Types: Can be based on technical indicators (e.g., ATR, Breakout, Acceleration/Deceleration) or price action patterns.
2.3 Bar Interval
- Definition: The time frame used for each data point in the backtest.
- Examples: Minute, hourly, daily, or weekly intervals.
- Purpose: Helps in analyzing trends over different time frames.
2.4 Last Traded Price (LTP)
- Definition: The most recent price at which the asset was traded.
- Importance: Crucial for calculating profits, losses, and returns.
3. Performance Metrics in Backtesting
3.1 Total Traded Positions
- Definition: Represents the total number of trades executed based on the strategy.
- Purpose: Helps determine whether the strategy is over-trading or under-trading.
3.2 Total Return (%)
- Definition: Measures the overall return generated by the strategy as a percentage.
- Purpose: A higher value indicates a profitable strategy.
3.3 Net Profit (Monetary Value)
- Definition: Shows the actual profit or loss achieved by the strategy.
- Interpretation: A positive value indicates profitability, while a negative value suggests a loss.
3.4 Winning Position Ratio (%)
- Definition: Represents the percentage of trades that resulted in a profit.
- Purpose: Higher values indicate a more successful strategy.
3.5 Losing Position Ratio (%)
- Definition: Indicates the percentage of trades that ended in a loss.
- Purpose: Helps assess risk exposure.
4. Risk Management Metrics
4.1 Reward-to-Risk Ratio
- Definition: Compares the potential profit to the potential loss.
- Interpretation: A value above 1.0 means potential profit is greater than risk.
4.2 Maximum Drawdown (%)
- Definition: Measures the largest percentage drop from the peak portfolio value to its lowest point before recovery.
- Purpose: A lower drawdown indicates a more stable strategy.
5. Trading Volume and Execution
5.1 Total Buy Amount
- Definition: The total money spent on all buy transactions during the backtest.
- Purpose: Shows how much capital was used to purchase assets.
5.2 Total Sell Amount
- Definition: Represents the total money received from all sell transactions during the backtest.
- Purpose: Shows how much capital was recovered from selling assets.
5.3 Profit or Loss Summary
- Definition: Represents the final monetary result of the strategy.
- Purpose: Indicates whether the strategy has made a profit or incurred a loss.
6. Why Backtesting is Important
- Validates a Strategy
- Helps determine if a trading approach is profitable.
- Risk Assessment
- Identifies potential losses and drawdowns before real trading.
- Optimizes Performance
- Adjusts parameters to improve strategy efficiency.
- Avoids Emotional Trading
- Provides a data-driven approach to decision-making.
7. Limitations of Backtesting
- Historical Performance ≠ Future Results
- Market conditions change, and past performance may not reflect future results.
- Overfitting Risk
- A strategy might perform well on past data but fail in real-time markets.
- Ignoring Trading Costs
- Slippage, commissions, and fees can impact real profits.
8. Backtest Example Summary
| Metric | Value | Description |
|---|
| Symbol | DLBS | The stock or asset being tested. |
| Strategy | AccelerationDeceleration | Strategy based on momentum indicators. |
| Bar Interval | Day | Time frame for each data point (daily). |
| LTP (Last Traded Price) | 1720 | Most recent trading price. |
| Total Traded Positions | 0 | Number of trades executed. |
| Total Return (%) | 1.00% | Overall return generated. |
| Net Profit | 0.00 | Total profit or loss. |
| Winning Position Ratio (%) | 0 | Percentage of profitable trades. |
| Losing Position Ratio (%) | 0 | Percentage of losing trades. |
| Reward-to-Risk Ratio | 0.0 | Profit potential vs. risk. |
| Maximum Drawdown (%) | 0.0% | Max drop from peak value. |
| Total Buy Amount | 0.00 | Capital used for buying. |
| Total Sell Amount | 0.00 | Capital recovered from selling. |
| Profit or Loss | 0.00 | Final outcome (profit or loss). |
9. Conclusion
Backtesting is an essential tool for traders to analyze and refine their strategies before executing real trades. By understanding performance metrics and risk factors, traders can make more informed decisions, improve profitability, and minimize potential losses. However, careful consideration of limitations is crucial to avoid false confidence in a strategy.
