Measuring a strategy honestly
A single headline return tells you almost nothing. These pages define every metric a professional uses to judge a backtest — return, risk-adjusted return, drawdown and edge measures — with the exact formula, how to read it, how professionals actually use it, and, crucially, the ways each number can mislead you. No metric is trusted alone; the craft is reading them together.
Performance Metrics: Backtest performance metrics fall into families: return (CAGR, absolute and annualized return), risk-adjusted return (Sharpe, Sortino, Calmar, information ratio), drawdown and pain (maximum drawdown, average drawdown, recovery factor, Ulcer index), and edge (profit factor, win rate, payoff ratio, expectancy). Each has a precise formula and a specific blind spot, so they are read together and always alongside the drawdown that shows how much pain earned the return.
CAGR (Compound Annual Growth Rate)
Return metricCAGR (compound annual growth rate) is the single constant yearly rate that, compounded over the full test period, would take the starting equity to t…
Absolute Return
Return metricAbsolute return is the total percentage change in equity from the start to the end of a backtest, computed as (End − Start) ÷ Start, with no adjustme…
Annualized Return
Return metricAnnualized return is a period return scaled to a full-year rate by geometric compounding, computed for a per-period return r over p periods per year …
Sharpe Ratio
Risk-adjustedThe Sharpe ratio is a risk-adjusted performance measure equal to the portfolio's excess return over the risk-free rate divided by the standard deviat…
Sortino Ratio
Risk-adjustedThe Sortino ratio is a risk-adjusted measure equal to the portfolio's excess return over a target divided by the downside deviation, the standard dev…
Calmar Ratio
Risk-adjustedThe Calmar ratio is a risk-adjusted measure equal to the compound annual growth rate divided by the absolute value of the maximum drawdown, expressin…
Information Ratio
Risk-adjustedThe information ratio is a risk-adjusted measure equal to the portfolio's active return over a benchmark divided by the tracking error, the standard …
Maximum Drawdown
Risk metricMaximum drawdown is the largest percentage decline from a historical peak to a subsequent trough in an equity curve, taken as the maximum over all po…
Average Drawdown
Risk metricAverage drawdown is the mean depth of the declines below the high-water mark across an equity curve, describing the typical pain a strategy inflicts …
Recovery Factor
Risk metricThe recovery factor is a risk metric equal to a strategy's net profit divided by the absolute value of its maximum drawdown, measuring how many times…
Profit Factor
Trade metricThe profit factor is a trade-level efficiency metric equal to the gross profit from all winning trades divided by the gross loss from all losing trad…
Win Rate
Trade metricThe win rate is the fraction of trades that close profitable, computed as the number of winning trades divided by the total number of trades, describ…
Payoff Ratio
Trade metricThe payoff ratio is a trade-level metric equal to the average winning trade divided by the average losing trade, describing how large the strategy's …
Expectancy
Trade metricExpectancy is the average profit or loss a strategy produces per trade, computed as the win rate times the average win minus the loss rate times the …
Ulcer Index
Risk metricThe ulcer index is a drawdown-based risk measure equal to the square root of the mean of the squared percentage drawdowns at every point in time, cap…