Final answer:
When backtesting a trading strategy, it's best to compare its returns to the market average, the strategy's initial investment, or other backtested strategies. The tradeoff between return and risk is critical in determining the suitability of any financial strategy for an investor.
Step-by-step explanation:
When backtesting a promising-looking trading strategy, the most common benchmark to compare the return it generates is with a) The market average. This comparison helps to determine if the strategy is outperforming the general market, which is a critical gauge of its effectiveness. However, depending on the investor's goals and risk tolerance, comparing against b) The strategy's initial investment, or c) Other backtested strategies might be relevant as well. It's less common and generally not as useful to compare it to d) The global GDP growth rate, as this measures economic output rather than direct financial market performance. When evaluating any investment strategy, it's essential to consider the tradeoff between return and risk. While some may prefer a safer investment with a lower expected return, others might opt for a riskier investment that has the potential for a higher return.
To assess the safety of an investment, consider the type of risks involved, such as default risk or interest rate risk. A safe investment is typically one that has a narrow range of potential outcomes and hence expected returns are close to actual returns consistently. Conversely, a riskier investment will see significant fluctuations in its returns. Examining the expected rate of return against the actual rate of return over time will provide a clearer picture of how the strategy performs in various market conditions.