V.17:6 (257-259): Buy-And-Hold Comparisons To Evaluate Stock Trading by Jack Schwager

V.17:6 (257-259): Buy-And-Hold Comparisons To Evaluate Stock Trading by Jack Schwager
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Buy-And-Hold Comparisons To Evaluate Stock Trading by Jack Schwager

Benchmark comparisons are a standard technique for the performance of a trading system. One particular benchmark is the buy-and-hold approach. This noted market analyst looks at the steps to using it.

Just because a trading system makes money in the stock market doesn’t mean it’s a good system. After all, it is possible for a system to do well but still fall short of the results that could have been realized by a simple buy-and-hold approach. The key question in testing a stock market system is: How does the system compare with the buy-and-hold approach?

THE PROBLEM Answering this question is not as simple as it might appear. In my previous article, we showed why a constant share size trade assumption led to severe distortions in testing trading systems and why a constant dollar trade size assumption was far preferable. The problem, however, is that system results based on a constant dollar trade size — for example, $1,000 — cannot be directly compared with buy-and-hold results for the same number of shares as the first trade.

To understand why, assume a stock is trading at $5 at the start of the test period before it then advances to $50 by the end of the survey period. In this case, 200 shares, which equal $1,000 at the start, would equal $10,000 at the end. In contrast, the constant dollar trade size system results would continue to assume a $1,000 trade size on each signal.

As a result, the buy-and-hold case would assume a much larger average position size as time elapsed. Consequently, a comparison between the system results and buy-and-hold results would be that of the proverbial apples and oranges.

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