# How to read a backtest: drawdown, CAGR, and Sharpe

> Drawdown, CAGR, volatility, Sharpe, benchmarks, and turnover, in the order worth reading them.

A backtest shows several numbers at once. This page explains them in the order
worth reading them.

## Start with the chart

The growth chart shows how $1 would have grown, next to the benchmark. Before
any number, look for the stretches where the strategy fell or went nowhere, and
how long they lasted. Ask yourself whether you would have kept following the
rules through them.

## Drawdown: read it first

**Maximum drawdown** is the biggest drop from a peak to a later low. It matters
more than it looks, because losses need bigger gains to recover:

| Drop | Gain needed to get back |
| --- | --- |
| −10% | +11% |
| −20% | +25% |
| −33% | +50% |
| −50% | +100% |

The drawdown chart also shows how long each recovery took. A strategy that
spends years below its old high is hard to stick with, whatever its final
return.

## Return: total and yearly

**Total return** is the growth over the whole backtest. **CAGR** is the steady
yearly rate that would give the same result. CAGR hides the path: two
strategies with the same CAGR can feel completely different to live through.

## Volatility and Sharpe

**Volatility** measures how much returns swing from day to day, scaled to a
year. **Sharpe** divides the average yearly return by volatility: higher means
more return for each bump along the way.

Tactfolio's main Sharpe doesn't subtract a risk-free interest rate. The figure
under it, **over T-bills**, subtracts the Treasury bill return first; use that
one to compare with other sites.

## Compare with a fair benchmark

Compare with what you would otherwise hold. A strategy that holds tech stocks
can look brilliant next to SPY simply because tech did well; that's why the
starter patterns compare with QQQ instead.

Then compare every number, not just return. Less return with a much smaller
drawdown can be a good trade. More return with a deeper drawdown isn't
automatically better. The **at same risk** row of the Reality checks table,
such as **SPY at same risk**, makes this comparison for you: the benchmark held
at the strategy's volatility, the rest in Treasury bills.

## Turnover and costs

**Turnover** is how much of the portfolio is traded each year. The more a
strategy trades, the more costs matter. Tactfolio charges a small cost on every
trade (slippage), but not taxes or commissions. The **Costs at 20 bps** and
**40 bps** rows show the same trades at higher costs; if the result falls apart
there, it depends on cheap trading.

## A checklist

- Does the backtest include at least one bad market, such as 2008, 2020, or
  2022?
- How deep was the worst drop, and how long did it take to recover?
- Does the strategy beat its benchmark on drawdown or Sharpe, not only on
  return?
- Does it survive higher costs?
- Does it hold up on dates you didn't tune it on? See
  [Why past results mislead](https://tactfolio.com/docs/concepts/why-past-results-mislead.md).

## Learn the ideas behind it

- [Max drawdown](https://tactfolio.com/learn/max-drawdown.md): Max drawdown is the biggest fall from a peak to a low.
- [Sharpe ratio](https://tactfolio.com/learn/sharpe-ratio.md): The Sharpe ratio measures return per unit of risk.
- [Calmar ratio](https://tactfolio.com/learn/calmar-ratio.md): The Calmar ratio divides yearly growth by the worst drop.
- [CAGR calculator](https://tactfolio.com/trading-tools/cagr-calculator.md): Turn a starting value, an ending value and the years between into a compound annual growth rate, with a worked example.