19th January 2023

Portfolio Backtesting: 5 Rules for Successful Investment

People often confuse investing with luck. The truth is - investing is mostly strategic. It requires skills and patience. With the right strategy, the chances of gaining exceed the chances of losing.

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Portfolio Backtesting: 5 Rules for Successful Investment

People often confuse investing with luck. The truth is – investing is mostly strategic. It requires skills and patience. With the right strategy, the chances of gaining exceed the chances of losing.

The world went through a global crisis as a result of COVID-19. This caused a negative financial impact, which led people to broaden their horizons regarding extra income.

That said, the number of people in Europe investing in the stock market is slowly increasing – around 33% of UK citizens and 15% of Germans.

Are you ready to embark on your successful investment journey?

If the answer is yes, you’ve come to the right place. This article will discuss the importance of portfolio backtesting strategy along with five rules for successful investment.

Let’s dive in!

The true meaning and importance of portfolio backtesting

Backtesting lets you test an investment strategy to understand how it would’ve performed in the past. So, before risking any capital, you’ll know the probability of the outcome.

Backtesting makes people more confident in their investment decisions. You’re probably thinking, how does it work?

Backtesting takes historical data into account. If a strategy wouldn’t do well in the past, it probably won’t do well in the future. It lets you know beforehand which strategies are worth your time and money. Even though we all know the market is always changing, stock patterns tend to repeat.

Portfolio backtesting has its benefits but is not always 100% accurate. It doesn’t predict the future, just gives you pointers. Still, analysts and professional traders are constantly using backtesting. They wouldn’t even consider risking big amounts if their strategy hasn’t previously been backtested.

To successfully backtest portfolio performance and improve your investments there is a set of rules you can follow.

5 rules for successful investment with backtesting

Consider various market conditions

See how your trading strategy performs during a tough economic crisis. Aim for a specific market condition, for example, The Asian Crisis of 1997, and then compare it with the COVID pandemic of 2020. Backtesting allows you to do this and is a great way to see how effective your strategy is when tried on different market conditions.

Make sure your portfolio contains at least 20 stocks

This allows us to lessen the likelihood that your strategy was simply fortunate and chose a successful stock by ensuring that no single stock will have a significant impact on the performance of your portfolio.

It gives you the certainty that your trading strategy will turn out to be profitable even if it has been applied to multiple stocks. This helps you greatly reduce your investment risk. So, if you’re trying to decide which backtesting tool works best for you, it’s better to choose one that gives you the option to select numerous stocks, instead of only one.

Have reasonable expectations

Even though trading can bring you wealth, don’t always set high expectations and expect to make a fortune overnight! If a strategy would’ve brought you 80.000$ twenty years ago, you can’t expect that same strategy to now bring you 800.000$.

It all depends on the risk you’re willing to take and the asset to wish to invest in. One thing is sure though – having proper expectations will never set you up for disappointment!

Take transaction cost into account

A lot of things can impact your investment profit, for example, the transaction cost of your broker. That’s why, when backtesting, it’s always better to consider them in advance. It gives a realistic point of view on things, so you won’t be confused if the return turns out to be lower than expected.

Aim for a longer period of backtesting

This world has suffered a lot of difficult times and all of them in different time frames. Considering the fact that backtesting works with historical data, backtest your strategy for at least fifteen years.

That way, you’ll cover different market conditions and if a market crash is to happen in the future, you’ll be able to adjust your strategy to it and still achieve the best possible outcome.

How to perform backtesting

Backtesting has been an option for investors for quite some time now. It has always been considered to be a time-consuming task, especially since in the past, it was mostly done manually, along with trading itself. Imagine manually calculating every moving average – it couldn’t have been easy.

Nowadays, the technology is so advanced that you can actually backtest your portfolio with the help of trading and backtesting software. It allows investors to test their strategy in a matter of seconds and save valuable time.

Some of the trading tools that don’t require coding are:

MetaTrader5TradingViewTradeStationAmibrokerEven though there are apps that don’t require coding, it’s still considered to be the most effective way to practice backtesting. Up to this day, the most popular programming language for traders remains Python.

Game-changing strategy

Portfolio backtesting is a huge advantage for both beginners and experienced traders. Firstly, it’s flexible and can be applied to various markets. Secondly, it’s just a simulation and no capital is involved in the process, therefore, you’re not risking anything.

Making your money work for you is not a bad idea at all. People understand this and are all about securing their future. That’s why investing has always been a popular trend and an effective way to potentially build wealth, especially when it’s strategically done.

Having said that, backtesting is a real game-changer. It can be used to significantly optimize your portfolio and improve your investments. Carlos Slim Helu once said ‘’With a good perspective on history, we can have a better understanding of the past and present, and thus a clear version of the future’’.

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