Understanding the backtest metrics
A backtest reports several performance and risk statistics. Here is what each of the headline output metrics means and how to read it.
- Sharpe ratio
- Average return divided by the volatility of returns — i.e. return per unit of total risk. Higher is better; above 1 is acceptable, above 2 is strong. It penalizes both upside and downside swings equally.
- Sortino ratio
- A variant of the Sharpe ratio that only counts downside volatility (losses) in the denominator. It rewards strategies that are volatile to the upside but steady on the downside, so it is often a fairer measure for asymmetric return profiles.
- Calmar ratio
- Annualized return divided by maximum drawdown. It tells you how much return you earned for the worst loss you had to endure — a higher Calmar means smoother, more recoverable performance.
- Max drawdown
- The largest peak-to-trough drop in account value over the test period, shown as a percentage. It is the single best gauge of how painful the strategy gets at its worst, and a key check on whether you could realistically stick with it.
Frequently Asked Questions
What is backtesting?
Backtesting is the process of running a trading strategy against historical price data to see how it would have performed in the past. It lets you measure a strategy's return, win rate, drawdowns, and risk-adjusted performance before risking real money. Backtest results are hypothetical and do not guarantee future performance — they describe the past, not the future — but they are an essential first filter for separating promising rule sets from poor ones.
What is a good Sharpe ratio?
The Sharpe ratio measures return per unit of risk (volatility). As a rough guide, a Sharpe ratio below 1 is considered subpar, around 1 is acceptable, 2 is very good, and 3 or higher is excellent. Be skeptical of unusually high backtested Sharpe ratios — they often come from overfitting to a short or cherry-picked period and rarely survive out-of-sample.
What is max drawdown?
Maximum drawdown is the largest peak-to-trough decline in account value during the backtest period, expressed as a percentage. It answers the question: what is the worst loss I would have had to sit through? A strategy with a 50% max drawdown loses half its value at its worst point, which most traders cannot tolerate psychologically. Lower drawdowns generally mean a smoother, more survivable equity curve.