The Baseline is the backtesting results from a very simple trading strategy. We use this as a basis for comparision. We do this to weed out the trading strategies that look good because they happened by chance to be in sync with the market over the test period. Instead we want to find the strategies that add value other than just riding the market.
Trading strategies must test out better than the baseline to be considered for live trading.
For example, an entry strategy with a 55% win rate might sound good by itself. But if the baseline had a 60% win rate over the same stocks and time period, that 55% strategy is actually a loser!
We test a simple strategy that enters the market at every opportunity and blindly exits at the end of specified hold periods. We choose the hold periods to match popular trading styles. This gives a win rate baseline. It also shows the market’s directional bias for the test period. We calculate the expectancy although this is not a real trading strategy.
This sample strategy has some dependence on the start date. We can measure it to see the impact. We can also reduce the start date impact by doing a random re-sampling using Monte Carlo simulation to get a more robust baseline.
The difference between “buy and hold” of a benchmark index and the baseline strategy is that the baseline takes into account the transaction costs of commission and slippage. The baseline also spends a fraction of the time out of the market between trades — overnight in the case of End-of-Day data.
Last updated 02/04/09.