Irrational Exuberance Meets Secular Stagnation (3)

Historical Stock PricesTechnical analysis is the art of identifying market price patterns to forecast future market price movements. If you would like to use the actual close rather than the adjusted close in Ambroker, replace the highlighted line above, with the line below and re-download all of your historical data from Yahoo. This means that a buy price shown in a backtest will not be the actual buy price that you could have received trading on that day (for any stock or ETF that at some point later in time issued a dividend or capital gain). This issue has a big impact on trade entry and exit signals with rotation/ranking systems…a system where a group of stocks/ETFs/mutual funds are being compared to each other based on open/high/low/close (OHLC) price data.

As an example, take a look at the historical data for the i Shares Core US Aggregate Bond (AGG) An excerpt of this historical data is shown in the image below. In the table below, is the comparison of entry and exit dates and vehicles for the strategy with the green equity curve in the above two charts. If my ranking system is using this adjusted data, then I am not using actual prices that I could have received in real trading.

Recall that the equity curves in the two charts above was generated by the same rotation strategy run against the same 10 ETFs in the list above…the only difference between the equity curves is the data…adjusted close data versus actual close data. After doing this for 12 months, of actual trading, using actual closing prices…run a backtest of this strategy on the adjusted price time series for this same basket of vehicles.Historical Stock Prices

I hope you both understand that with a ranking/rotation based system that operates on a static basket of vehicles (that pay dividends and cap gains), your system will generate different back test results every month that you test your system when you use adjusted data. I challenge you both to run a rotation/ranking system on the last day of each month starting this month, and to write down the score/rank for each of the vehicles in your basket, along with the closing price…use buy-on-close orders…on the last day of each month.

So unless you can demonstrate that backtesting a model on adjusted close prices has a negative effect when placing live orders at the real time price or makes a backtest model extra prone to failure in real time, I fail to see what the alarm is for anything other than relative ranking schemes. More importantly, with every new dividend/cap gain payout the adjusted prices time series will change. However, if I were to use a momentum measure for ranking (e.g. 6 month returns), adjusted data is fine. What I have seen several times is this: I receive a signal one month to enter a certain fund, say FLVCX.

Historical Stock Prices