Backtesting is useless

[Heydrrich]

You analyze the reason why people are on ET with a tunnel vision.
There are not only people who come to ET to find answers that can improve their trading. There are also people who come here to kill time while waiting to open or close a trade. I spent my time here while waiting to open or close trades.
I am not wasting my time here, I am spending it here. A huge difference.

PS: I never understood why people who start, many times start with options. If you buy a stock and the price goes up $5, you made $5 profit before expenses. If you would buy an option on that stock and the stock would move up $5, you never know where you will end with your profits, or even losses. I have a friend who traded options, and was most of the time right about the direction of the price, yet many times while he was right he did not make money.

Well personally i'd never say that I know everything and I assumed most people would think this. It seems that I have learned that there ARE really smart people who know it ALL and yet visit ET .....

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Anyway, I am asking these questions because I'd like to define the problem of backtesting, and understand what others see as backtesting, in order to determine whether or not it can be useful. So I am trying to learn here.

H

 

[virtusa]

Well personally i'd never say that I know everything and I assumed most people would think this. It seems that I have learned that there ARE really smart people who know it ALL and yet visit ET .....

If these smart people think they know everything, they only proof not to be smart. In general stupid people think they are smart.

You don't need to know everything (how can you even know you know everything?), if you are smart you understand that even with a decent amount of knowledge you can survive in trading.

I don't know much about trading, but I understand the basics and master them well enough to be consistently profitable.

 

[ironchef]

If you do not have a positive expectation, no amount of money management will help you. In fact, even with perfect risk management you are going to be bleeding transaction costs every time you trade.

But according to @Buy1Sell2 it is the Only True Edge:

https://www.elitetrader.com/et/thre...ment-is-the-only-true-edge-in-trading.292728/

What if risk management can turn a negative expectation method into one with positive expectation?

 

[Tradex]

Would you? Does it mean that it would not be profitable in the future?

Again, the question is very simple: a backtest shows that trading system X has been losing 10% a year on average, for the last 30 years.

Would you trade such a system, now?

Would you buy this system, if it was for sale?

A simple YES or NO will do.

 

[ironchef]

Every week when I sit down at a cafe there are some fishermen who have caught big fish every week. At the table next to it are a number of cycling tourists who know better how to win a race than the professionals.
If you want to meet the professionals you should go to a cafe.

Just come to ET and you will meet all the professionals and an occasional mom & pop amateur retails like me.

 

[ironchef]

The backtest of trading system X reveals that the average return on investment per year is -10% (that's MINUS 10%) for the last 30 years.

Would you trade trading system X?

Absolutely. I would.

Trade the inverse of system X.

I am not kidding, I backtested buying put options on SPY, going back 25 years and consistently got negative returns. So, I don't buy puts, rather I sell puts.

 

[Aquarians]

Absolutely. I would.

Trade the inverse of system X.

I am not kidding, I backtested buying put options on SPY, going back 25 years and consistently got negative returns. So, I don't buy puts, rather I sell puts.

Prepare to be baffled!

If a trading system loses by doing buys, doing the reverse (i.e. selling) IS NOT going to win!

Why? Because of the spread. Think the fair value in terms of probability was 50%, with bids at 45% and asks as 55%. If you buy @ ask, you'll lose 5% on average. If you do the reverse, guess what? You'll sell at bid, still a 5% loss on average

Crossing the spread and still making money, that's hard.

 

[Tradex]

If a trading system loses by doing buys, doing the reverse (i.e. selling) IS NOT going to win!

Losing system X trades once a year. Here are the results for the last 5 years (in US dollars):

2020 (so far): -75,000
2019: -45,000
2018: -125,000
2017: -85,000
2016: -15,000

Total loss: $345,000

Question: how much money would you have now if you had simply bet against System X?

 

[ironchef]

Prepare to be baffled!

If a trading system loses by doing buys, doing the reverse (i.e. selling) IS NOT going to win!

Why? Because of the spread. Think the fair value in terms of probability was 50%, with bids at 45% and asks as 55%. If you buy @ ask, you'll lose 5% on average. If you do the reverse, guess what? You'll sell at bid, still a 5% loss on average

Crossing the spread and still making money, that's hard.

I tested writing puts instead of buying, they were consistently profitable. True, I didn't account for the spread. Also, I could have bugs and wrong assumptions in my codes since no one checked them for errors.

In real life trading I actually did something similar. When I first started, I mechanically wrote covered calls and didn't make any money, so I reversed and wrote cash secured puts, came out better.

Anyway, I am not defending what I did, just wanted to present the other side as food for thought.

Take care.

 

[ironchef]

Why? Because of the spread. Think the fair value in terms of probability was 50%, with bids at 45% and asks as 55%. If you buy @ ask, you'll lose 5% on average. If you do the reverse, guess what? You'll sell at bid, still a 5% loss on average

Crossing the spread and still making money, that's hard.

Options 101: Never buy on ask and sell on bid. Always use limit price to trade.