1. Make sure you have enough data that the result is not due to chance. 10 years of monthly data is laughably insufficient IMHO.
2. Make sure that you did not let your subconscious brain conveniently cherry pick a place and a time of high performance as your backtest playground. That is, make sure the data is representative of at least the breadth of past scenarios. Protip: it is quite unusual for stock markets have such high returns. They rarely last. Have a look at the Japanese Stock market over the last 50 years. Or the Chinese stock market in recent years. Or the 1930s in the US.
3. Make sure your optimal leverage is not right next to a ‘cliff’ in the parameter space where even slightly more leverage would have wiped you out.
I did a similar analysis going back to 1926 for the US alone and found that the optimal leverage was a very fragile 10%. 20% did far worse.
Many people tell me they are bullish on America and so the USA outperformance (best in the world over many periods in living memory) will continue. OK, you are bullish on a country that will pick either Donald Trump or Joe Biden as the president for the next 4 years. Good luck!! Would you have been bullish on the USA when its outperformance started, shortly after a ruinous civil war, with rampant corruption and civil disturbances, only barely emerging from developing country status?
10 years of monthly data is laughably insufficient IMHO.
Not sure where you got the “monthly” (I’d be using daily bars at the coarsest), but I quite agree. Market data is extremely noisy. But going too far back in history doesn’t necessarily help because market conditions change. There were a lot of exploitable patterns historically that no longer hold. So rather than going deep, go broad. Diversify and look at patterns that hold for a basket of assets. And be cautious of old patterns that don’t appear in recent data.
Make sure that you did not let your subconscious brain conveniently cherry pick a place and a time of high performance as your backtest playground
It’s the recent history of what I’m actually investing in. I will have more to say about overfitting later in the sequence.
Make sure your optimal leverage is not right next to a ‘cliff’
A fractional-Kelly bet should not behave like that, especially if you’re diversified. Even in the Nikkei when it had a return of zero (1984-2009), the optimal leverage of about 0.5x would have produced positive growth.
Of course, I can’t guarantee that a nuclear war won’t destroy the world and your portfolio with it. For some level of black-swan risk, you’ve got more pressing concerns than your rate of return.
I did a similar analysis going back to 1926 for the US alone and found that the optimal leverage was a very fragile 10%. 20% did far worse.
Details matter. How were you rebalancing? If you still have the data handy, I’m curious how the risk-parity allocation would have done.
OK, you are bullish on a country that will pick either Donald Trump or Joe Biden as the president for the next 4 years.
I know, right? On the other hand, America’s institutions have shown some remarkable resilience, despite Trump’s efforts to dismantle them (the current pandemic fiasco notwithstanding).
Important points to add
1. Make sure you have enough data that the result is not due to chance. 10 years of monthly data is laughably insufficient IMHO.
2. Make sure that you did not let your subconscious brain conveniently cherry pick a place and a time of high performance as your backtest playground. That is, make sure the data is representative of at least the breadth of past scenarios. Protip: it is quite unusual for stock markets have such high returns. They rarely last. Have a look at the Japanese Stock market over the last 50 years. Or the Chinese stock market in recent years. Or the 1930s in the US.
3. Make sure your optimal leverage is not right next to a ‘cliff’ in the parameter space where even slightly more leverage would have wiped you out.
I did a similar analysis going back to 1926 for the US alone and found that the optimal leverage was a very fragile 10%. 20% did far worse.
Many people tell me they are bullish on America and so the USA outperformance (best in the world over many periods in living memory) will continue. OK, you are bullish on a country that will pick either Donald Trump or Joe Biden as the president for the next 4 years. Good luck!! Would you have been bullish on the USA when its outperformance started, shortly after a ruinous civil war, with rampant corruption and civil disturbances, only barely emerging from developing country status?
Not sure where you got the “monthly” (I’d be using daily bars at the coarsest), but I quite agree. Market data is extremely noisy. But going too far back in history doesn’t necessarily help because market conditions change. There were a lot of exploitable patterns historically that no longer hold. So rather than going deep, go broad. Diversify and look at patterns that hold for a basket of assets. And be cautious of old patterns that don’t appear in recent data.
It’s the recent history of what I’m actually investing in. I will have more to say about overfitting later in the sequence.
A fractional-Kelly bet should not behave like that, especially if you’re diversified. Even in the Nikkei when it had a return of zero (1984-2009), the optimal leverage of about 0.5x would have produced positive growth.
Of course, I can’t guarantee that a nuclear war won’t destroy the world and your portfolio with it. For some level of black-swan risk, you’ve got more pressing concerns than your rate of return.
Details matter. How were you rebalancing? If you still have the data handy, I’m curious how the risk-parity allocation would have done.
I’m interested in what you think of this paper.
Or at least the summary here.
I know, right? On the other hand, America’s institutions have shown some remarkable resilience, despite Trump’s efforts to dismantle them (the current pandemic fiasco notwithstanding).