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Monday33
Weird but very good performance on a sim, looking for thoughts

Hello to all of you guys.

I would like to comment a sim with all of you. The result or the return it's pretty good, the sim and it's commands are extremely simple, too much to me, and I do not know how must I take it.

I rank the sim just by P/E, the lower the better, take 100 stocks, rebalance twice a year, and buy just with the Sharpe ratio. There is no more.

I attached the files here, you can have a look at them.

Then, I would like to know your opinion;

Is this "system" reliable?

Can we expected a similar future performance?

Is that a mistake that comes from data?

What do you think about that?

Thanks to all.

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Jan 5, 2019 2:59:20 AM       
hemmerling
Re: Weird but very good performance on a sim, looking for thoughts

Well, I would say yes and no. It just had roughly 45% drawdown so that's a pretty massive tumble. Excluding 2018, it looks about 13.5%. Assuming you are investing in illiquid stocks with a value tilt that might take in the good and the bad? Maybe. Without further analysis though - it is hard to tell how much risk you are holding. Also, are there any liquidity requirements? Does this include stocks under 10 cents and trading $1,000 per day? Because then the 13.5% isn't realistic due to compounding needed in tiny stocks. And if you can only trade $100 a day in these stocks, transaction costs and commissions would eat 10% of your capital per trade.

So without knowing anything more - I would say that yes, you can get 13.5% annually by making some risky bets and realizing that you can lose 50% in your first year when the market goes down 10%.

I would be inclined to throw in a liquidity filter, limit short interest, make sure earnings are positive for the past 5 years and at least 1 analyst per stock. See where that takes you. You can still trade twice a year but maybe you can eliminate some potential volatility.

Jan 5, 2019 6:24:26 AM       
davidbv
Re: Weird but very good performance on a sim, looking for thoughts

Monday33, I would recommend you read Marc Gerstein's tutorial series on how to create models from fundamenatl data.
it is here:
https://www.portfolio123.com/doc/side_help_item.jsp?id=200

He explains how you should interpret P/E, how it is a good metric and how it can mislead you. I can give you my own opinion but he has done a much better job of it.

the long and short of it is: don't just use P/E (along with just Sharpe). It can lead you astray.

David

Jan 5, 2019 6:47:25 AM       
Jrinne
Re: Weird but very good performance on a sim, looking for thoughts

Monday33, I would recommend you read Marc Gerstein's tutorial series..

And I think what Kurtis says about liquidity is probably equally important.

What Marc has to say is very important. But let me use my own language (a little bit).

First, everyone would have to agree that you have not overfit your model I would think. After all you have only one variable and and have not limited your universe at all. And you are using a rational factor.

Marc has much say about overfitting. But it can be easily summarized to: use rational factors (which you are doing).

But once you are committed to using rational factors then much of what Marc has to say regards the problems of UNDER-FITTING. He uses a pretty much equivalent term of misspecification. BTW, Marc understands the mathematics of all of this much better than he likes to admit.

There is another related concept that Marc likes to discuss. That is interaction of the variables. His models do well in large part (I think) because he used factors that interact with each other in a positive way. He uses ideas that are well developed from his finance degrees and his experience. But he also confirms that there is some interactions with backtesting, I think. The use of rational factors, factors that interact in a rational manner and limited backtesting reduces the overfitting of his models: again this is my perception and Marc will probably state it differently (assuming I have not missing the mark entirely).

So I think you may be good to go once you have addressed any liquidity concerns (to your satisfaction). The low turnover rate does make this less of a concern compared to high turnover models. I would also start the model on different dates and/or use rolling backtests. The 6 month rebalance limits the number of data points in your study and you want to make sure that you have not picked a lucky start date.

But if you are looking for the very best model, you are probably under-fit, or MISSPECIFIED (to use Marc’s parlance). Probably more importantly (IMHO), you could at least look at Marc’s ideas on factors that interact in a positive way.

FWIW.

-Jim

We are drowning in information and starving for knowledge.
— John Naisbitt.

Jan 5, 2019 7:05:58 AM       
Edit 6 times, last edit by Jrinne at Jan 5, 2019 10:26:37 AM
ivillalongabarreiro
Re: Weird but very good performance on a sim, looking for thoughts

I have replicated the same simulation with a liquidity rule and the performance falls by half.

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Jan 5, 2019 8:58:25 AM       
Edit 1 times, last edit by ivillalongabarreiro at Jan 5, 2019 9:04:40 AM
Monday33
Re: Weird but very good performance on a sim, looking for thoughts

Hi Hemmerling.

When you said "limit short interest", what amount of short interest do you recommend?

Thanks.

Jan 5, 2019 9:14:27 AM       
Monday33
Re: Weird but very good performance on a sim, looking for thoughts

Hi David.

To be honest I just read the Portfolio 123 manual, not the Marc Gerstein's tutorial series. Now it's my duty for the days ahead. ;)

Thanks!

Jan 5, 2019 9:23:41 AM       
hemmerling
Re: Weird but very good performance on a sim, looking for thoughts

I mean, just play around a little. Under 10% or under 5% should be fine. Just remove stuff that seems like it could have higher volatility risk going forward.

Jan 6, 2019 10:15:08 PM       
hemmerling
Re: Weird but very good performance on a sim, looking for thoughts

This is a very simple example of adding a few basic filters to your idea. It still trades 100 lowest PE stocks. It re-constitutes every 52 weeks.

Attachment 100-Low-PE-Stocks.jpg (271483 bytes) (Download count: 88)


Jan 6, 2019 10:31:35 PM       
Monday33
Re: Weird but very good performance on a sim, looking for thoughts

Wow!!! Thanks a lot Hemmerling. You help me a lot to understand what happens.

Thanks to all of you too, Ivillalongabarroeiro, Jim and David.

Jan 7, 2019 1:36:43 AM       
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