By Engineering Returns
This post is about the impact of survivorship bias on various types of strategies. I want to look at mean-reversion as well as trend-follow strategies to see how their performance gets impacted by using today’s stock index constitution vs. a historical correct definition aka survivorship bias free.
- Indices: NDX100, SP100, SP500
- All trades are close/close, no trading cost
- 25 concurrent positions / 4% size
- Data adjusted for splits and cash dividend
For the first test I run a simple mean-reversion strategy. Enter the trade when RSI3 < 25 and exit when RSI3 > 75. Of course one can argue that these aren’t the perfect levels. However it should be good enough to understand the impact. In case multiple entries occur the ones with the lowest RSI3 values are picked.
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The strategy performed significantly worse on a survivorship bias free definition. This can be seen among all three major indices.
Trend Following (long only)
In a second step I looked into trend following. Buying 25 stocks with the highest RSI14 value using a rotational trading approach.
Again, the performance difference is very significant on all three indices.
Trend Following (short only)
At the end I want to look into SHORT trades using a trend following approach. Shorting the 25 stocks with the lowest RSI14 (rotational).
In this case the takeaway is different. The survivorship bias-free version is performing somewhat better on all three indices. I think this is due to the fact that the system has more candidates to choose from, especially in past years when the survivorship bias is more pronounced.
In all cases the results were significantly different and therefore leading to faulty decisions during the strategy development process. One can not get an accurate picture of his or her strategy without considering survivorship-bias. I’m stressing this point because I continue to see people using today’s index definition in order to backtest strategies. Should you have an interest on testing your index-stock strategies in a reliable way then read this for further information.