Backtesting: Difference between revisions
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Here's what www.investopedia.com has to say about backtesting: | Here's what [http://www.investopedia.com investopedia] has to say about backtesting: | ||
{{box|'''Backtesting''' is the process of testing a trading strategy on relevant historical data to ensure its viability before the trader risks any actual capital. A trader can simulate the trading of a strategy over an appropriate period of time and analyze the results for the levels of profitability and risk.}} | {{box|'''Backtesting''' is the process of testing a trading strategy on relevant historical data to ensure its viability before the trader risks any actual capital. A trader can simulate the trading of a strategy over an appropriate period of time and analyze the results for the levels of profitability and risk.}} | ||
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Which makes it sound sensible, measured, prudent and not the systematically moronic idea it is. | Which makes it sound sensible, measured, prudent and not the systematically moronic idea it is. | ||
Backtesting is one of those cognitive dissonances that, for now, | Backtesting is one of those cognitive dissonances that has passed, for now, into embarrassed history, but is sure to re-emerge the moment the markets regain their giddily optimistic resting state. Markets are fueled by the self-confident delusions of vain men. | ||
Once upon a time a resourceful [[salesperson]] with a clever new product (one that, you know, embedded [[leveraged alpha]], or something) had to go through the motions of justifying its “extraordinary potential”<ref>i.e., for [[sales credits]]</ref> when pitching it to {{sex|his}} [[mark]]s<ref>Did I say “[[mark]]s”? I meant “sophisticated [[client]]s properly categorised for [[MiFID]] purposes as [[Professional client - COBS Provision|professionals]] who weren’t carpet-bagging blaggers, had the slightest clue what they were about, effortlessly saw [[charlatan]]s coming a mile off and weren’t remotely influenced by the [[corporate entertainment]] — golf, motor racing, fine dining and [[hookers]] — with which they were lavishly festooned”.</ref>. | |||
The problem with financial markets was, is, and always will be this: ''you can’t anticipate the future''. This isn’t a shortcoming of contemporary risk management theory | The problem with financial markets was, is, and always will be this: ''you can’t anticipate the future''. This isn’t a shortcoming of contemporary risk management theory: it’s in a market’s very nature. If you ''could'', you couldn’t make money betting on it. | ||
You know the story about the [[frog and the scorpion]], right? | You know the story about the [[frog and the scorpion]], right? | ||
So these randy [[salespeople]] needed something their [[client]]s could take back to their risk committee to demonstrate the rigorous financial analysis that had gone into their product design. Then a lightbulb moment: [[backtesting]]. There may be no data from the future, but there’s buckets of the stuff from the past. Here your [[Bloomberg]] terminal is | So these randy [[salespeople]] needed something their [[client]]s could take back to their risk committee to demonstrate the rigorous financial analysis{{tm}} that had gone into their product design{{tm}}. Then a lightbulb moment: ''[[backtesting]]''. [[There is no data from the future|There may be no data from the future]], but there’s buckets of the stuff from the past. Here your [[Bloomberg]] terminal is your friend. All you need are ninja [[Excel]] skills — every blighter has those — and you can compare how your ingenious strategy would have done against [[benchmark]]s and [[beta|market averages]] had you run it for the last five years. | ||
Which you haven't been doing, because you only just thought it up, because this strategy never would have occurred to you had you not known how the markets had actually behaved over the last five years. | Which you haven't been doing, because you only just thought it up, because this strategy never would have occurred to you had you not known how the markets had actually behaved over the last five years. ''There was no data from the future in the past.'' | ||
And how would it perform? Unless ''you'' are a bigger knucklehead than your [[client]], SPECTACULARLY. Whatever the weather. You designed it, with 20:20 hindsight, specifically to look good against this exact data set, remember? However mendacious you might be, the ruse is so obvious that no client who entertained it for a moment deserves any sympathy at all. Yet | And how would it perform? Unless ''you'' are a bigger knucklehead than your [[client]], SPECTACULARLY. Whatever the weather. You designed it, with 20:20 hindsight, specifically to look good against this exact data set, remember? However mendacious you might be, the ruse is so obvious that no client who entertained it for a moment deserves any sympathy at all. Yet in their thousands, they did. | ||
They worked it out eventually. The hard way. | They worked it out eventually. The hard way. | ||
Thanks to the “chart” function in [[Microsoft Excel]] could render these illustrations in animated multicoloured, three-dimensional graphs, splatter analyses | Thanks to the “chart” function in [[Microsoft Excel]] could render these illustrations in animated multicoloured, three-dimensional graphs, splatter analyses. In every case the strategy outperformed [[beta]] and any other indicator in the market that the salesperson cared to represent. But the restaurant booking was in twenty minutes, so the client had seen all he needed to see. | ||
Revision as of 10:03, 17 March 2017
Here's what investopedia has to say about backtesting:
- Backtesting is the process of testing a trading strategy on relevant historical data to ensure its viability before the trader risks any actual capital. A trader can simulate the trading of a strategy over an appropriate period of time and analyze the results for the levels of profitability and risk.
Which makes it sound sensible, measured, prudent and not the systematically moronic idea it is.
Backtesting is one of those cognitive dissonances that has passed, for now, into embarrassed history, but is sure to re-emerge the moment the markets regain their giddily optimistic resting state. Markets are fueled by the self-confident delusions of vain men.
Once upon a time a resourceful salesperson with a clever new product (one that, you know, embedded leveraged alpha, or something) had to go through the motions of justifying its “extraordinary potential”[1] when pitching it to his marks[2].
The problem with financial markets was, is, and always will be this: you can’t anticipate the future. This isn’t a shortcoming of contemporary risk management theory: it’s in a market’s very nature. If you could, you couldn’t make money betting on it.
You know the story about the frog and the scorpion, right?
So these randy salespeople needed something their clients could take back to their risk committee to demonstrate the rigorous financial analysis™ that had gone into their product design™. Then a lightbulb moment: backtesting. There may be no data from the future, but there’s buckets of the stuff from the past. Here your Bloomberg terminal is your friend. All you need are ninja Excel skills — every blighter has those — and you can compare how your ingenious strategy would have done against benchmarks and market averages had you run it for the last five years.
Which you haven't been doing, because you only just thought it up, because this strategy never would have occurred to you had you not known how the markets had actually behaved over the last five years. There was no data from the future in the past.
And how would it perform? Unless you are a bigger knucklehead than your client, SPECTACULARLY. Whatever the weather. You designed it, with 20:20 hindsight, specifically to look good against this exact data set, remember? However mendacious you might be, the ruse is so obvious that no client who entertained it for a moment deserves any sympathy at all. Yet in their thousands, they did.
They worked it out eventually. The hard way.
Thanks to the “chart” function in Microsoft Excel could render these illustrations in animated multicoloured, three-dimensional graphs, splatter analyses. In every case the strategy outperformed beta and any other indicator in the market that the salesperson cared to represent. But the restaurant booking was in twenty minutes, so the client had seen all he needed to see.
See also
References
- ↑ i.e., for sales credits
- ↑ Did I say “marks”? I meant “sophisticated clients properly categorised for MiFID purposes as professionals who weren’t carpet-bagging blaggers, had the slightest clue what they were about, effortlessly saw charlatans coming a mile off and weren’t remotely influenced by the corporate entertainment — golf, motor racing, fine dining and hookers — with which they were lavishly festooned”.