Simulation as a Stock Market Backtesting Tool

44 Pages Posted: 17 Apr 2014

Date Written: April 16, 2014

Abstract

Backtesting stock market investment strategies is fraught with danger – for example, overfitting. The signal to noise ratio in stock markets is so low that overfitting is inevitable. Simulation offers a means of assessing and compensating for the dangers. It is not obvious at first how simulation can be helpful for backtesting and predicting markets but we show in five examples how this can be done. Techniques discussed are smoothing and regularization and are applied to investment strategies such as moving average crossover rules, momentum rules, and dynamic regression rules.

Keywords: Backtesting, Simulation, Smoothing, Data Mining Bias, Overfitting, Regularization, Moving Averages, Momentum, Alpha-Momentum

JEL Classification: C02, C15, C18, C52, C53, C63, G17

Suggested Citation

Cooper, Tony, Simulation as a Stock Market Backtesting Tool (April 16, 2014). Available at SSRN: https://ssrn.com/abstract=2425436 or http://dx.doi.org/10.2139/ssrn.2425436

Tony Cooper (Contact Author)

Double-Digit Numerics ( email )

Auckland
New Zealand

HOME PAGE: http://www.ddnum.com

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