How do you select your portfolio of stocks for your system? Do you:
- 1) Simply use the constituents of some well known indices such as S&P or Russell?
- 2) Define the list based on some fundamental/technical characteristics such as market cap, avg volume, etc?
- 3) Apply your system to all the stocks and include those that meet certain performance criteria?
- 4) Have some other procedures that you wouldn't mind discussing just a bit?
On a related topic, how do you deal with the pesky problem of survival bias? That is, in your testing, how do you account for stocks that no longer exist due to bankrupcy, M&A, LBO, or whatever other reasons? I've done some search on the Internet and found that historical data for defunct stocks are generally hard to find and very expensive. Even if you find them, they could be a maintenance nightmare due to symbol changes and all sorts of corporate actions.
So do you:
- a) Simply go out and buy all the necessary data for all the defunct stocks and include them in your testing?
- b) Design your system in such a way to avoid or minimize the inclusion of defunct stocks over your test period? This way, you only need to obtain and maintain a manageable amount of defunct stock data.
- c) Exclude them all together from your test data and simply discount them in your final test results (i.e. just assume that they will negatively impact your performance results such as Sharpe, W/L Ratio, etc by 30% or some such number).
- d) Again, have some other procedures that you wouldn't mind discussing just a bit?