backtest-expert-zc

# Backtest Expert Systematic approach to backtesting trading strategies based on professional methodology that prioritizes robustness over optimistic results. ## Core Philosophy **Goal**: Find strategies that "break the least", not strategies that "profit the most" on paper. **Principle**: Add friction, stress test assumptions, and see what survives. If a strategy holds up under pessimistic conditions, it's more likely to work in live trading. ## When to Use This Skill Use this skill when: - Developing or validating systematic trading strategies - Evaluating whether a trading idea is robust enough for live implementation - Troubleshooting why a backtest might be misleading - Learning proper backtesting methodology - Avoiding common pitfalls (curve-fitting, look-ahead bias, survivorship bias) - Assessing parameter sensitivity and regime dependence - Setting realistic expectations for slippage and execution costs ## Backtesting Workflow ### 1. State the Hypothesis Define the edge in one sentence. **Example**: "Stocks that gap up >3% on earnings and pull back to previous day's close within first hour provide mean-reversion opportunity." If you can't articulate the edge clearly, don't proceed to testing. ### 2. Codify Rules with Zero Discretion Define with complete specificity: - **Entry**: Exact conditions, timing, price type - **Exit**: Stop loss, profit target, time-based exit - **Position sizing**: Fixed $$, % of portfolio, volatility-adjusted - **Filters**: Market cap, volume, sector, volatility conditions - **Universe**: What instruments are eligible **Critical**: No subjective judgment allowed. Every decision must be rule-based and unambiguous. ### 3. Run Initial Backtest Test over: - **Minimum 5 years** (preferably 10+) - **Multiple market regimes** (bull, bear, high/low volatility) - **Realistic costs**: Commissions + conservative slippage Examine initial results for basic viability. If fundamentally broken, iterate on hypothesis. ### 4. Stress Test the Strategy This is where 80% of testing time should be spent. **Parameter sensitivity**: - Test stop loss at 50%, 75%, 100%, 125%, 150% of baseline - Test profit target at 80%, 90%, 100%, 110%, 120% of baseline - Vary entry/exit timing by ±15-30 minutes - Look for "plateaus" of stable performance, not narrow spikes **Execution friction**: - Increase slippage to 1.5-2x typical estimates - Model worst-case fills (buy at ask+1 tick, sell at bid-1 tick) - Add realistic order rejection scenarios - Test with pessimistic commission structures **Time robustness**: - Analyze year-by-year performance - Require positive expectancy in majority of years - Ensure strategy doesn't rely on 1-2 exceptional periods - Test in different market regimes separately **Sample size**: - Absolute minimum: 30 trades - Preferred: 100+ trades - High confidence: 200+ trades ### 5. Out-of-Sample Validation **Walk-forward analysis**: 1. Optimize on training period (e.g., Year 1-3) 2. Test on validation period (Year 4) 3. Roll forward and repeat 4. Compare in-sample vs out-of-sample performance **Warning signs**: - Out-of-sample <50% of in-sample performance - Need frequent parameter re-optimization - Parameters change dramatically between periods ### 6. Evaluate Results **Questions to answer**: - Does edge survive pessimistic assumptions? - Is performance stable across parameter variations? - Does strategy work in multiple market regimes? - Is sample size sufficient for statistical confidence? - Are results realistic, not "too good to be true"? **Decision criteria**: - ✅ **Deploy**: Survives all stress tests with acceptable performance - 🔄 **Refine**: Core logic sound but needs parameter adjustment - ❌ **Abandon**: Fails stress tests or relies on fragile assumptions ## Key Testing Principles ### Punish the Strategy Add friction everywhere: - Commissions higher than reality - Slippage 1.5-2x typical - Worst-case fills - Order rejections - Partial fills **Rationale**: Strategies that survive pessimistic assumptions often outperform in live trading. ### Seek Plateaus, Not Peaks Look for parameter ranges where performance is stable, not optimal values that create performance spikes. **Good**: Strategy profitable with stop loss anywhere from 1.5% to 3.0% **Bad**: Strategy only works with stop loss at exactly 2.13% Stable performance indicates genuine edge; narrow optima suggest curve-fitting. ### Test All Cases, Not Cherry-Picked Examples **Wrong approach**: Study hand-picked "market leaders" that worked **Right approach**: Test every stock that met criteria, including those that failed Selective examples create survivorship bias and overestimate strategy quality. ### Separate Idea Generation from Validation **Intuition**: Useful for generating hypotheses **Validation**: Must be purely data-driven Never let attachment to an idea influence interpretation of test results. ## Common Failure Patterns Recognize these patterns early to save time: 1. **Parameter sensitivity**: Only works with exact parameter values 2. **Regime-specific**: Great in some years, terrible in others 3. **Slippage sensitivity**: Unprofitable when realistic costs added 4. **Small sample**: Too few trades for statistical confidence 5. **Look-ahead bias**: "Too good to be true" results 6. **Over-optimization**: Many parameters, poor out-of-sample results See `references/failed_tests.md` for detailed examples and diagnostic framework. ## Available Reference Documentation ### Methodology Reference **File**: `references/methodology.md` **When to read**: For detailed guidance on specific testing techniques. **Contents**: - Stress testing methods - Parameter sensitivity analysis - Slippage and friction modeling - Sample size requirements - Market regime classification - Common biases and pitfalls (survivorship, look-ahead, curve-fitting, etc.) ### Failed Tests Reference **File**: `references/failed_tests.md` **When to read**: When strategy fails tests, or learning from past mistakes. **Contents**: - Why failures are valuable - Common failure patterns with examples - Case study documentation framework - Red flags checklist for evaluating backtests ## Critical Reminders **Time allocation**: Spend 20% generating ideas, 80% trying to break them. **Context-free requirement**: If strategy requires "perfect context" to work, it's not robust enough for systematic trading. **Red flag**: If backtest results look too good (>90% win rate, minimal drawdowns, perfect timing), audit carefully for look-ahead bias or data issues. **Tool limitations**: Understand your backtesting platform's quirks (interpolation methods, handling of low liquidity, data alignment issues). **Statistical significance**: Small edges require large sample sizes to prove. 5% edge per trade needs 100+ trades to distinguish from luck. ## Discretionary vs Systematic Differences This skill focuses on **systematic/quantitative** backtesting where: - All rules are codified in advance - No discretion or "feel" in execution - Testing happens on all historical examples, not cherry-picked cases - Context (news, macro) is deliberately stripped out Discretionary traders study differently—this skill may not apply to setups requiring subjective judgment.