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How to back test your investment strategy - Real world example

As you know the Quant Investing stock screener also allows you to back test your investment strategy.

This article shows you how to back test your investment strategy with a real world example.

You can also download the spread sheet containing all of the back test data and calculations – it’s at the bottom of the article.

 

Back test of the Magic Formula Momentum investment strategy

This article shows you the back test of the Magic Formula combined with momentum ( Price Index 6 months) investment strategy in Europe over the four year period from January 2016 to December 2019.

It is a further back testing of this investment strategy: Magic Formula investing & Price Index 6m momentum investment strategy

 

The exact screener settings

Here are the exact details of the back tested investment strategy:

  • Countries - 17 Eurozone countries (Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain)
  • Exclude banks, insurance companies, investment funds, certain holdings companies, and REITS
  • Exclude companies with an average 30-day trading volume of less than €10,000
  • Portfolios formed on the first trading day of the year (Because the back test database is point in time there is not risk of look-ahead bias)
  • Returns were compounded on an annual basis
  • Select the 20% best ranked Magic Formula companies
  • Sort the list by Price Index 6 months from high to low
  • Buy the top 50 companies by Price Index 6 months on an equal weight basis
  • Rebalance after one year

 

This is what the screen looks like.

Magic Formula back test Europe 1

 

How to screen the past

This is how you can start using the historical point in time back test database.

I expand on all these points below but here are the steps if you know the screener:

  1. Login and go to the screener
  2. Set up or load a screen
  3. Click on the Historical Screener icon
  4. Select the date in the past from where you want the screener results for
  5. Select the future closing price date to where you want to calculate returns
  6. Click Confirm to get the historical screener results

 

Here are the detailed steps

Here are the detailed steps for you to back test your investment strategy using the back test point in time database.

 

1. Login and Set up or load a saved screen

For instructions on exactly how to log in and set up a screen look at this article: How to run your first screen with the Quant Investing screener

 

2. Get historical results of your screen

Once you have run your screen and you have a list of companies that currently fit the screen criteria you are ready to go back in time.

To do this click on the Historical Screener icon to open the Historical Screener date selector.

Quant Investing back test 1

A window will the open where you can select two dates.

The first date is the date in the past you want to the screener to run and give you investment ideas. The closing stock prices on this date will automatically be loaded.

You can also (you do not have to) select a second closing price date.

If you add a second date the Historical Screener will automatically calculate the stock price percentage change from the past screener date to the second closing price date.

For example , if you choose to run the historical screener on 3 January 2016 and enter 30 June 2016 as the second date the screener will automatically calculate the stock price return from 3 January 2016 to 30 June 2016 for you.

This makes it easy to see how your investment strategy has performed.

To select the past date you would like to screen for click the top date selector icon.

Quant Investing back test 2

To select a date you can either click the blue left arrow or click on the date heading as shown below.

Quant Investing back test 3

Next select a second closing stock price date.

The Historical Screener will calculate returns from the above selected screener date to this date.

Quant Investing back test 4

After selecting the date click the Confirm button to start the historical screen.

Quant Investing back test 5

That is all you have to do to screen past results.

 

If there is No Data

As you saw you can only select weekdays in the above date selector. However it may be that the day you selected was a market holiday with no closing price.

If it was a market holiday you will see a "No data" message like this:

Quant Investing back test 6

If you do get the No data message simply select a day before or after the date you selected.

 

What were the returns of your back test?

The results of your back test will look like this:

Quant Investing back test 7

  1.  Shows you what saved screen you are back testing
  2. Shows you the date you are back testing (companies that fit your screen on that past date)
  3. Shows you the saved Template you are using. A Template is a saved collection of columns displayed with a screen.
  4. The closing stock price on the date you are back testing. The date shown in 2.
  5. The second closing price you selected when you ran the historical screener.
  6. The percentage change from the closing price in 4 to the closing price in 5.

 

If the returns look unusual or funny

If the returns of companies in your back rest look unusual or funny, -100% or no return for example. You will have to do a bit of research as the back test function does not save the last price before a company terminates its listing.

This may happen when a company gets taken over or goes bankrupt.

To find the last price the company traded at simply do an internet search with its name. An article is sure to come up on what happened to the company.

Use this price to calculate the company's back tested return. The easy solution will be to use Microsoft Excel.

 

Export to Excel for more calculations

If you want to calculate more return numbers remember you can export the above results to Microsoft Excel.

To export to Excel just click on the Export Data to MS Excel icon.

Quant Investing back test 8

   

Clean up the back test data

Remember the past data in the database is just as it actually was in the past. This means you may have to make a few changes.

For example, if the second closing price is empty it means the company delisted in the period.

To fix this search the internet for the company name along with delisted or takeover. Find the last trading price or takeover price, enter it in your spread sheet and calculate the return.

Stock splits or consolidations

Use the conditional formatting function in Excel to quickly find the companies with the biggest price movements.

Magic Formula back test Europe 2


If you see very wild return numbers, positive or negative there may have been a stock split or stock consolidation. To check the return numbers go to Google Finance or Yahoo finance and search the company name and check if the stock prices are correct. You can also search the internet for company name and stock split or consolidation.

Once you find the information just correct it in the spread sheet and calculate the return.

 

Getting back the Magic Formula investment strategy back test

Getting back to how the Magic Formula Momentum investment strategy performed.

Here are the summarised results:

Magic Formula back test Europe 3

As you can see the strategy performed well in 2016 and 2017 but ended up not beating the market ( EURO STOXX® Index ) on a CAGR basis.

This was mainly because of the bigger loss of 26% recorded in 2018.

 

Here is the back test spread sheet

Click on the link below to download the spread sheet with the Magic Formula Europe investment strategy back test:

Magic Formula Europe Back Test 

 

That is how easy it is for you to back test your investment strategy.

 

Your questions welcome

As always if you need help to use the back tester let us know.

 

PS Not a subscriber to the Quant Investing stock screener and back tester yet? Sign up here.

PPS Why not sign up right now before it slips your mind?