Backtest Basics

What is a Backtest?

A backtest simulates how a trading strategy, called a "symphony," might have performed in the past using historical data. It’s important to note that these simulations make certain assumptions and differ from live trading symphonies.

Key Points to Understand

Hypothetical Nature: All backtest results are hypothetical and benefit from hindsight.
Past Performance: Past performance is not a reliable indicator of future performance.
Estimation: Backtests estimate how a model performs under specific market conditions and are not recommendations for actual trading decisions in the past or the future.

Data Sources

Backtests: We use daily adjusted closing prices, accounting for corporate actions like dividends or splits, to simulate historical trading decisions. These prices don’t represent real quotes from any point during the trading day.
Live Trading: When a symphony is traded live, trading decisions are made during the trading period using real-time data, which represent real quotes on the market.

Trading Period

Time of Day: Live trading happens during the trading period between 3:45 PM and 4:00 PM Eastern Time on market days. Decisions made during this window may differ from those suggested by a backtest due to end-of-day volatility.
Intra-day Variations: High volatility can lead to different decisions even for different instances of the same symphony due to varying real-time quotes.

Dividends and Distributions

Backtests and Live Trading: Both scenarios assume reinvestment of dividends and distributions into the symphony.

Costs Considered

Trading Pass: Backtests include estimates for Composer’s Trading Pass ($30 monthly or $288 annually at a 20% discount). Remember, the Trading Pass is charged per user, not per symphony. If you invest in multiple symphonies, the effective fee per symphony is significantly lower than what is modeled.
Regulatory Fees: These include US Securities & Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA) fees on asset sales, directly passed to the respective authorities.
SEC Fee: Charged at $5.10 per $1,000,000 of principal sold, rounded up to the nearest penny per transaction.
FINRA Trading Activity Fee (TAF): $0.000119 per share sold, rounded up to the nearest penny per transaction, with a maximum of $5.95 per transaction.
Slippage: Slippage reflects the potential cost difference between hypothetical trades in your backtest and actual trades that might encounter price movement and spread. The amount of slippage is influenced by market conditions, liquidity, and bid-ask spreads. The default slippage setting in backtests is 5 basis points (bps).

Benchmarks and Indices

Purpose: Used only for illustrative purposes and provided for the purpose of making general market data available as a point of reference only.
Limitations: Benchmarks and financial indices are unmanaged, assume reinvestment of income, do not reflect the impact of any trading commissions and costs, management and incentive fees and have limitations when used for comparison because they may have a different trading strategy, volatility, credit or other material characteristics (such as limitations on the number and types of securities or instruments).
Benchmark choice: The S&P 500 is not the only index used as a benchmark for measuring the performance of a portfolio. Depending on the holdings in your portfolio, your investment objectives, and your risk tolerance, it may be more appropriate to measure performance against a different benchmark.

Backtesting Compared to Other Platforms

Assumptions Vary: It’s crucial to understand that different platforms may use different assumptions in their backtests. We recommend users familiarize themselves with these details before making comparisons.

Always consider economic factors, market conditions, and investment strategies when evaluating the potential performance of a portfolio. There are no guarantees that a strategy will match or outperform any particular benchmark.