Truth in Backtesting (Part 6)

So far in this series (e.g. http://www.optionfanatic.com/2012/12/04/truth-in-backtesting-part-5/), I have discussed the misleading nature of EOD backtesting when trade delays are not used.  Today I want to use the Consecutive Directional Close (CDC) system to start discussing another misleading aspect of backtesting:  multiple positions.

Consider this the beginning of a new day.  I wake up bright and early (well not so bright because I really do like to wake up extremely early), jump out of bed, and shake off all book knowledge pertaining to system development that I have accumulated over the past couple of years.  My mind reverts to old patterns of knowledge.  I just got AmiBroker and now I’m ready to play.

I start by coding the CDC system and setting the filter to S&P 500 stocks.  I set initial equity to $50,000,000, maximum number of open positions to 500, number of CDCs to four, and length of trades to five.  I set position size to $100,000 and I include a couple other filters in the buy and short conditions:  Bollinger Band breakdown or breakout and price above or below the 200-SMA for long and short trades, respectively.  I include a liquidity filter to make sure the position size divided by closing price is less than 1% of the average daily volume over the past 50 days.  Backtesting dates are 1/1/1980 through 11/30/2012.  Commissions are assessed at $8/trade.  Buys and sells are executed at the next open.

The results for backtest #21463 are as follows:

RAR = risk-adjusted return (i.e. performance if the system were in the market 100% of the time)
Payoff Ratio = average winning trade / average losing trade
RAR/MDD = the subjective function

I will use PF and SR as abbreviations for Profit Factor and Sharpe Ratio, respectively.

These results aren’t bad, but I want to see if I can make the system more efficient.  I increase CDC to five.  Here are the results of backtest #21464:

These results are better.  While net profit is lower, the system has become more efficient (PF is higher along with payoff ratio, subjective function, and SR).

I will continue this analysis in my next post.