Backtesting Trading Strategies with Python¶

How to Backtest, Securitize and Optimize Your Trading Strategies¶

May, 2017

Agenda¶

Common backtesting pitfalls (and how to avoid them)
Pros & cons of different types of backtesting
Measuring backtest performance
Optimizing strategy parameters
Robustness testing with monte carlo
From back-testing to forward-testing

Common Backtesting Pitfalls

(and how to avoid them)

Common Backtesting Pitfalls¶

Data snooping (look-ahead bias)
Backtesting on in-sample data
Overfitting
Overtrading
Using survivor-biased data
Not considering market impact / slippage
Buy more shares than actually available
Pure Luck :-)

Pitfall:
Data snooping (look-ahead bias)

Solution:
Use an event based backtester to makes future data unavailable

[********************** DATA SET **********************]
1. [ AVAILABLE DATA **************]|
                                   ^
2. [ AVAILABLE DATA ************************]|
                                             ^
3. [ AVAILABLE DATA ****************************]|
                                                 ^
...

Pitfall:
Backtesting on in-sample data

Solution:
Split data into a train set and a test set

[********************** DATA SET **********************]
[********** IN-SAMPLE **********][*** OUT-OF-SAMPLE ***][*** FWD TEST ***]

Pitfall:
Overfitting

Solution:
Simplify your trading rules

Pitfall:
Overtrading

Solution:
Simplify your trading rules

Pitfall:
Using survivor-biased data

Solution:
Obtain and test on clean, survivor-free data

Pitfall:
Not considering market impact / slippage

Solution:
Be prepare to have the price move against you and subtract a few basis points from every trade (depending on the market)

Pitfall:
Buying more shares than actually available

Solution:
Limit strategy to only trade a certain percentage of the total daily volume

Pitfall:
Pure luck :-)

Solution:
Stress-test your strategy and always forward test before going live

Strategy Development Workflow¶

Come up with a trading idea
Run a vectoried backtest - for quick validation of ideas
Run a event-based backtest - to eliminate data snooping and other pitfalls
Optimize and Scrutinize
Forward Testing
Paper Trading
Live Trading

First, let's get some data to work with¶

In [3]:

from pandas_datareader import data as pdr
import fix_yahoo_finance

spy = pdr.get_data_yahoo("SPY", start="2000-01-01", auto_adjust=True)

spy.columns = map(str.lower, spy.columns)
spy['return'] = spy['close'].pct_change().fillna(0)

spy.head()

Out[3]:

	open	high	low	close	volume	return
Date
2000-01-03	148.250000	148.250000	143.875000	145.4375	8164300	0.000000
2000-01-04	143.531204	144.062500	139.640594	139.7500	8089800	-0.039106
2000-01-05	139.937500	141.531204	137.250000	140.0000	12177900	0.001789
2000-01-06	139.625000	141.500000	137.750000	137.7500	6227200	-0.016071
2000-01-07	140.312500	145.750000	140.062500	145.7500	8066500	0.058076

Quick Recap:
Vectorized vs. Event Based Backtesting

Vectorized Backtesting¶

Pros:¶

Very fast - great for quickly testing ideas
Requires much less coding compared to alternatives

Cons:¶

Danger of data snooping
Usually cannot be used "as-is" for live trading

Event-Based Backtesting¶

Pros:¶

More reliable backtesting (no look-ahead bias)
Code can be used "as-is" for live trading

Cons:¶

Takes longer to write and run your backtest

Basic Strategy Example¶

BUY ON CLOSE when SPY drops 0.5% (or more)
SELL ON CLOSE of next day

Vectorized Backtesting¶

In [4]:

timer.start()

port = pd.DataFrame(spy['return'])
port['strategy'] = port[port['return'].shift(1) <= -0.005]['return']

timer.stop()

[*] Total runtime: 2.47 ms

Event Based Backtesting¶

In [5]:

timer.start()

port = pd.DataFrame(spy['return'])

for ix, _ in port.iterrows():
    loc = port.index.get_loc(ix)
    if loc > 0:
        yday = port.iloc[loc - 1]
        if yday['return'] <= -0.005:
            port.loc[ix, "strategy"] = port.loc[ix, 'return']

timer.stop()

[*] Total runtime: 860.38 ms

Using `atw`¶

In [6]:

timer.start()

port = pd.DataFrame(spy['return'])

for ix, loc in atw.iterate(port, progress=True):
    yday = port.iloc[loc - 1]
    if yday['return'] <= -0.005:
        port.loc[ix, 'strategy'] = port.loc[ix, 'return']

timer.stop()

[*********************100%***********************]  4376 of 4376 complete

[*] Total runtime: 4.63 s

Measuring Performance¶

Basic Performance Metrics¶

Sharpe Ratio - risk adjusted return of investment
Max Drawdown - max hole (and it's duration)
Recovery Factor - how quickly the strategy recovers from drawdowns (net profit/max dd)
CAGR (Compound Annual Growth Rate) - annualized % growth return
Profit Factor - profit from winning trades / losses from losing trades
Win Rate - % of trades with a net profit > 0
Yearly/Monthly/Quarterly/Daily/Hourly Breakdown - seasonality discovery
Avg. Return per Trade
Avg. Return from Winners/Losers per Trade
Total Returns

Eyeballing Performance¶

In [7]:

port.fillna(0, inplace=True)
port.cumsum().plot()

Out[7]:

<matplotlib.axes._subplots.AxesSubplot at 0x10e928c88>

Onto the math...¶

Sharpe Ratio¶


Sharpe(X) = (rX - Rf) / StdDev(X)

Where:¶

X is the investment
rX is the average rate of the return of X
Rf is the best available risk-free security (i.e. T-bills)
StdDev(X) is the standard deviation of rX

In [8]:

returns = port['strategy'][port['strategy'] != 0]
sharpe = np.sqrt(252) * (np.mean(returns)) / np.std(returns)

sharpe

Out[8]:

1.2459348946091056

Max Drawdown¶

In [9]:

dd = pd.DataFrame(data={"percent": port['strategy'].cumsum()})
dd['duration'] = np.where(dd['percent'] < 0, 1, 0)
dd['duration'] = dd['duration'].groupby(
                        (dd['duration'] == 0).cumsum() ).cumcount()

dd[['percent', 'duration']].plot(figsize=(14, 5), subplots=True)

Out[9]:

array([<matplotlib.axes._subplots.AxesSubplot object at 0x11036dcf8>,
       <matplotlib.axes._subplots.AxesSubplot object at 0x1104255f8>], dtype=object)

Plotting Under Water¶

In [10]:

dd['max'] = dd['percent'].rolling(len(dd), min_periods=1).max()

fig, ax = plt.subplots(figsize=(14, 6))
ax.plot(dd['percent'], lw=1.5)
ax.fill_between(dd.index, dd['percent'], dd['max'], color='c', alpha=.5)

Out[10]:

<matplotlib.collections.PolyCollection at 0x1146e77f0>

Recovery Factor¶

In [11]:

max_dd = dd['percent'].min()
total_returns = sum(port['strategy'])
recovery_factor = total_returns / abs(max_dd)

recovery_factor

Out[11]:

9.060807135217356

CAGR (Compound Annual Growth Rate)¶


CAGR(X) = (Vt / V0) ^ (1 / yearsX) - 1

Where:¶

X is the strategy
Vt is the value at the current portfolio value
V0 is the value at the starting portfolio value
yearsX is the total number of years the strategy ran

In [12]:

start_value = 1
end_value = 1 + sum(port['strategy'])
years = len(returns.resample("A").count())
cagr = ((end_value / start_value) ** (1 / years)) - 1

cagr

Out[12]:

0.049828309156602746

Moving along... :)¶

In [13]:

dd = atw.drawdown(port['strategy'])

stats = [
    ("Sharpe ratio", "%.2f" % atw.sharpe(port['strategy'])),
    ("CAGR", "%.2f%%" % (atw.cagr(port['strategy']) * 100)),
    ("Win %", "%.2f%%" % (atw.win_rate(port['strategy']) * 100)),
    ("Avg. %", "%.2f%%" % (atw.avg_return(port['strategy']) * 100)),
    ("Avg. Win %", "%.2f%%" % (atw.avg_win(port['strategy']) * 100)),
    ("Avg. Loss %", "%.2f%%" % (atw.avg_loss(port['strategy']) * 100)),
    ("Profit Factor", "%.2f" % atw.profit_factor(port['strategy'])),
    ("Max DD %", "%.2f%%" % (dd['percent'].min() * 100)),
    ("DD Duration %", "%.0f days" % dd['duration'].max() ),
    ("Recovery Factor", "%.2f" % atw.recovery_factor(port['strategy'], dd['percent']))
]

stats = pd.DataFrame(stats, columns=['metric', 'value'])
stats.set_index(stats.columns[0], inplace=True)

print(stats)

                    value
metric
Sharpe ratio         1.25
CAGR                4.98%
Win %              55.76%
Avg. %              0.13%
Avg. Win %          1.09%
Avg. Loss %        -1.09%
Profit Factor        1.26
Max DD %          -15.45%
DD Duration %    149 days
Recovery Factor      9.06

YoY Returns¶

In [14]:

atw.sum_by_year(port).plot(kind='bar')

Out[14]:

<matplotlib.axes._subplots.AxesSubplot at 0x110344c88>

Monthly Returns¶

In [15]:

atw.monthly_returns_heatmap(port['strategy'])

Optimizing Your Strategy¶

In [16]:

# split the data into training and testing sets
train, test = atw.train_test_split(spy, test_size=.2)

Strategy Idea¶

GO LONG where Fast SMA >= Slow SMA
GO SHORT where Fast SMA < Slow SMA

In [17]:

port = pd.DataFrame(train)
port['ma1'] = port['close'].rolling(window=50).mean()
port['ma2'] = port['close'].rolling(window=100).mean()

In [18]:

port[['ma1', 'ma2', 'close']].plot(linewidth=1)

Out[18]:

<matplotlib.axes._subplots.AxesSubplot at 0x115a027b8>

Backtesting Trading Strategies with Python¶

How to Backtest, Securitize and Optimize Your Trading Strategies¶

Agenda¶

Common Backtesting Pitfalls

(and how to avoid them)

Common Backtesting Pitfalls¶

Pitfall:Data snooping (look-ahead bias)

Solution:Use an event based backtester to makes future data unavailable

Pitfall:Backtesting on in-sample data

Solution:Split data into a train set and a test set

Pitfall:Overfitting

Solution:Simplify your trading rules

Pitfall:Overtrading

Solution:Simplify your trading rules

Pitfall:Using survivor-biased data

Solution:Obtain and test on clean, survivor-free data

Pitfall:Not considering market impact / slippage

Solution:Be prepare to have the price move against you and subtract a few basis points from every trade (depending on the market)

Pitfall:Buying more shares than actually available

Solution:Limit strategy to only trade a certain percentage of the total daily volume

Pitfall:Pure luck :-)

Solution:Stress-test your strategy and always forward test before going live

Strategy Development Workflow¶

Strategy Development Workflow¶

First, let's get some data to work with¶

Quick Recap:Vectorized vs. Event Based Backtesting

Vectorized Backtesting¶

Pros:¶

Cons:¶

Event-Based Backtesting¶

Pros:¶

Cons:¶

Basic Strategy Example¶

Vectorized Backtesting¶

Event Based Backtesting¶

Using atw¶

Measuring Performance¶

Basic Performance Metrics¶

Eyeballing Performance¶

Onto the math...¶

Sharpe Ratio¶

Where:¶

Max Drawdown¶

Plotting Under Water¶

Recovery Factor¶

CAGR (Compound Annual Growth Rate)¶

Where:¶

Moving along... :)¶

YoY Returns¶

Monthly Returns¶

Optimizing Your Strategy¶

Strategy Idea¶

Pitfall:
Data snooping (look-ahead bias)

Solution:
Use an event based backtester to makes future data unavailable

Pitfall:
Backtesting on in-sample data

Solution:
Split data into a train set and a test set

Pitfall:
Overfitting

Solution:
Simplify your trading rules

Pitfall:
Overtrading

Solution:
Simplify your trading rules

Pitfall:
Using survivor-biased data

Solution:
Obtain and test on clean, survivor-free data

Pitfall:
Not considering market impact / slippage

Solution:
Be prepare to have the price move against you and subtract a few basis points from every trade (depending on the market)

Pitfall:
Buying more shares than actually available

Solution:
Limit strategy to only trade a certain percentage of the total daily volume

Pitfall:
Pure luck :-)

Solution:
Stress-test your strategy and always forward test before going live

Quick Recap:
Vectorized vs. Event Based Backtesting

Using `atw`¶