Momentum Rotation Strategies and Data - Part 2

In Part 1, I discussed an issue that can occur when using dividend adjusted price data in Momentum Rotation Strategies that select funds based on a relative ranking algorithm.  I outlined three different data approaches that can be used, and presented a simple rotation strategy and portfolio to illustrate this data issue.  For additional background please see Part 1, and my older post: Historical Data and Momentum Rotation Strategies

In this post we will dive right into the backtest results.  In the diagram below, three equity curves are displayed for the simple 60 day dual momentum Rotation System outlined in Part 1.

60 Day Momentum Rotation Strategy Equity Curves
(click to enlarge)
 The blue curve labeled "Adjusted" is the equity curve generated from our momentum system using dividend and split adjusted data.  The signals and P&L are derived only from the adjusted data time series.  The red curve labeled "Actual" is the equity curve generated from our momentum system using only split adjusted data, that has not been adjusted for dividends.  It is lower, as expected, since dividend are not included.  The green curve labeled "Hybrid" is the equity curve generated from our momentum system using the "Actual" time series for signal generation and the "Adjusted" time series for the P&L calculation.  This is a two step process...first the system is run across the "Actual" time series data to derive the trade dates and ETFs selected.  The second step use the dates and ETFs selected in step 1 to to calculate P&L from the "Adjusted" time series data.

For this example, I selected a portfolio of ETFs and a Rotation System that had a small difference between the Hybrid and Adjusted data equity curves.  If Adjusted data did not have an impact on ranking, then the two curves would exactly overlap.

What we can see in the next two images are the signals, or ETFs selected, by the strategy from the "Actual" data set and the "Adjusted" data set.  The chart below shows the ETFs selected (and held) by the strategy by date using the "Actual" time series data.

ETF Holdings By Date From Actual Data Signals
(click to enlarge)
The chart below shows the ETFs selected (and held) by the strategy by date using the "Adjusted" time series data.  It is obvious when comparing the chart above with the cart below that the signals, or ETFs selected do not match...although they are close!

ETF Holdings By Date From Adjusted Data Signals
(click to enlarge)
In my view, this is a pretty clear sign that using dividend adjusted price data will cause your relative ranking systems to generate results, and signals, that will change with time.  I have experienced this first hand with my live rotation systems.  Occasionally I will receive a signal to sell one ETF and buy another ETF...where the ETF I am supposed to sell is not the ETF that I am actually holding from the prior month's signal...when real money is on the line, understanding the cause of this situation is vitally important!

In the next post, we will look at another example...

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