Adrian Reid breaks down three levels of backtesting for trading systems. Most traders skip the critical second step: coding explicit rules and running them across decades of data to measure historical drawdowns. Without knowing your worst losses, you can't tell if a strategy will survive long enough to work.
There's several different levels of backtesting. The first level is where you look at a chart and you say, okay, look, there's a buy. Yep, there's a sell. Okay, now there's another buy and there's another cell that's manual back testing on the chart where basically you're lining up your indicators, you're having the buy and sell arrows and you're looking along and you're recording wins and losses in a manual way. That's a base level. The next level up is testing in a systemized way where you put your rules into software and you apply those rules to much more market history. 20, 30 years, over thousands of stocks or cryptocurrencies or futures markets, whatever you're trading and you assemble a portfolio of trades based on that system and you see how the portfolio would have performed over time. This is the second, the next level. Now that's really critical because it tells you about the drawdown that you would have suffered in the past because that's the primary driver of whether or not you'll be able to stay in the game and the number one driver of long term success. The first and most important thing is to stay in the game because if we wipe ourselves out, if we blow up an account, we're out of the game, we can't keep trading. So we really need to back test to understand are we going to stay in the game? Can I survive long term trading like this? Does this make sense? Yeah. So back testing in a systemized way, your set of rules over many decades of market history. The next level above that is combining multiple systems together and testing them together to see how those systems interact. And that's, that's the advanced level where you understand how is your, how effective is your diversification.
