backtesting the secret weapon of smart traders
Before you risk a single rupee, ask yourself: has your strategy worked before? In the fast-paced world of trading, every decision counts. But relying on gut instinct or tips from social media isn’t a strategy—it’s a gamble. That’s where backtesting comes in. It analyses historical market data to reveal patterns, pitfalls, and potential. By applying your trading strategy to past market data, you can objectively evaluate how it would have performed.
In this blog, we’ll break down what backtesting is, why it matters, how to do it step-by-step, and how to interpret key performance metrics like a pro. More importantly, we’ll show how you can use it to refine your strategies for long-term success in today’s dynamic markets, like navigating the volatility we’ve seen from late 2024 to early 2025.
If you’re serious about building a successful trading system—one that doesn’t rely on hype, guesswork, or emotion—then backtesting is your proving ground.
Backtesting is the process of simulating a trading strategy using historical data to evaluate how it would have performed in the past. It’s not about predicting the future—it’s about validating assumptions. Think of it as running your strategy through a time machine to test its consistency, edge, and risk profile under various market conditions.
When done right, backtesting answers critical questions like:
In short, it helps you avoid costly mistakes and optimize for long-term compounding, ensuring your strategy is robust enough for real-world investing.
Before running a backtest, you need to define what success looks like. Here are some key metrics that can reveal a strategy’s true performance:
CAGR shows the annual return of your strategy over time, smoothing out volatility to reflect compounded growth.
Why it matters: It lets you compare your strategy’s performance against benchmarks like the Nifty 50 over long periods. A CAGR above 15% can be generally strong for equity strategies.
This measures the largest peak-to-trough drop in your portfolio’s value, expressed as a percentage.
Why it matters: A 30% CAGR is meaningless if it comes with a 60% drawdown—most traders can’t stomach that. Drawdowns lesser than 25% can be considered as a good sign (in most cases)
RoMaD compares your total return (or CAGR) to the maximum drawdown, showing how much return you earn per unit of drawdown risk. In short, it shows how much profit you make compared to the biggest loss your investment faced.
Why it matters: A RoMaD above 1 means your profits are bigger than your worst loss, which is a good sign. For example, a 20% CAGR with a 10% drawdown gives a RoMaD of 2—meaning you’re getting twice the return compared to the risk. It helps you see if the strategy’s gains are worth the tough times.
On sharpely, you get a comprehensive Performance Summary with these key data points. In addition, it also provides deeper insights such as the Worst 5 Drawdowns, Calendar Year Returns, and more—all within a single, easy-to-read table.
The Sharpe Ratio measures risk-adjusted return, showing how much return you earn per unit of volatility.
Why it matters: A higher Sharpe Ratio (ideally >1) means your returns are efficient—higher returns without excessive risk. A ratio below 0.5 signals poor risk management.
On sharpely, we go one step beyond giving you a comprehensive look at the performance metrics that matter. Want a sneak peek?
Want to see how our ‘Warren Buffet’ screener performs? Explore here.
Before you backtest, you need a strategy, right? On sharpely, you have got an option to create a fully automated strategy. (Don’t know how to do that? Don’t worry we’ve covered it all in detail in our blog here.)
Now for others, who’re fairly acquainted with strategy building, here’s a quick refresher before we dive deep into ‘real’ backtesting.
Step 1: Define Clear Rules
Set entry, exit, and rebalancing rules to eliminate emotional bias.
Example:
“Market Cap > 50000 AND P/E < 50.”
“Rebalance every quarter.”
“Exit RSI > 75.”
[Want to learn how to build a successful strategy in just 7 steps? Watch our FREE Masterclass here.]
Step 2: Gather Clean Historical Data
Use high-quality data that includes dividends, and splits, and is bias-free (i.e., if your benchmark index is Nifty 50, and you’re running a backtest for 5 years. The tool shouldn’t just use today’s Nifty 50 stocks as default, but include & exclude all the stocks that were a part of Nifty 50 in the past 5 years.)
Why? This ensures you’re testing a real-world scenario, not cherry-picking winners.
Step 3: Apply Your Strategy Logic
Run your strategy over at least 10 years of historical data using a robust backtesting engine. This helps you evaluate its performance across various market cycles. For instance, a backtest from 2021 to 2023 might look impressive simply because of the market’s bullish phase. But if your strategy holds up during challenging periods—like the downturn in 2024–25 or the sharp decline during the COVID crash—it’s a strong signal that you’re onto something truly resilient.
Step 4: Analyze Core Metrics
Evaluate key metrics like CAGR, Sharpe Ratio, Maximum Drawdown, Volatility, and Rolling Returns across different time frames to truly understand your strategy's performance. On sharpely, we take it a step further by showcasing the 6-month rolling Sharpe Ratio against the benchmark index—offering a deeper and more dynamic perspective.
Step 5: Compare with Benchmarks
Measure your strategy against benchmarks like Nifty 50, Nifty 100, or Midcap indices. You want to outperform the market—otherwise, an index fund is a better bet, right?
Step 6: Refine Based on Insights
Did drawdowns spike in bear markets? Add an exit condition or trailing stop loss. Did returns lag in sideways markets? Adjust rebalancing frequency or add a momentum filter.
Imagine a strategy boasting a 25% CAGR over 10 years. Impressive, right? But what if it suffered a 70% drawdown in 2020 and had a Sharpe Ratio of just 0.6? That’s a red flag.
Another good example is covered in this article here. Here we’ve used a screener that filters High Momentum Stocks. Now this strategy is great for traders, but if you’re a risk-averse individual the drawdown of this strategy is too high (compared to the benchmark.)
This is where backtesting saves you. It forces you to look beyond returns and understand their cost. A strategy that tests your nerve in tough times won’t last, no matter how flashy the headline numbers.
If you're serious about strategy, you need a backtesting engine that’s just as serious. sharpely is designed for traders who demand precision, speed, and depth—without the headache of complex code.
At its core, sharpely offers a highly accurate backtesting engine that processes bias-free data—with dividends and stock splits factored in, ensuring that what you see is a true reflection of how your strategy would’ve performed. No shortcuts. No blind spots.
And with a no-code interface, sharpely is perfect for beginners, and also has advanced features for seasoned traders who demand granular control. Whether you're looking to automate strategy testing or dive deep into performance analytics, sharpely is built to keep up with your ambition.
Just take a look at some of the rich visualizations the platform’s backtesting report offers:
sharpely doesn’t just show you the numbers—it tells the story behind your strategy: where it thrives, where it falters, and where it needs refinement.
With sharpely, backtesting isn’t a guessing game—it’s a strategic advantage.
Backtesting separates traders from gamblers. It enforces discipline, builds conviction, and lets you sleep soundly, knowing your strategy rests on hard data, not blind faith.
In 2025’s fast-moving markets, backtesting is more crucial than ever. Combine it with sound risk management, stock selection, and position sizing, and you’re not just trading—you’re building a legacy of wealth.
