Is Research On Trading Rules Implementable? The Case Of Short-Term Contrarian Strategies

Abstract:     
Research on trading rule profitability usually simulates trading on historical data. These data usually are obtained from files such as CRSP, which estimate closing prices as the last trade (at the closing bid or the closing ask, or neither), or the bid-ask average (in the absence of a last trade). A trading rule could not normally be implemented at these prices, for even a smaller number of shares. A simulated contrarian strategy transforms noise in closing price estimates into return biases, by buying at predominantly bid prices and shorting at ask, which is not implementable for most investors. The bias in estimated contrarian portfolio returns is severe. For example, when returns are calculated from successive bid prices of NASDAQ stocks, short-term contrarian profits largely disappear

JEL Classification: G1

working papers series