Backtest Methodology

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This page explains our momentum basket trading methodology, data sources, assumptions, and limitations. Understanding these details is crucial for interpreting our backtested results.

Strategy Overview

Our momentum basket strategy identifies stocks with strong price momentum from the NASDAQ 100 index. The strategy is based on academic research showing that stocks with strong recent performance tend to continue outperforming in the short to medium term.

Selection Criteria

• Universe: NASDAQ 100 stocks (largest non-financial companies)
• Momentum Calculation: 6-month and 12-month price momentum
• Market Cap Filter: Only stocks above $10 billion market cap
• Liquidity Filter: Minimum average daily volume requirements
• Rebalancing: Monthly portfolio rebalancing

Data Sources & Quality

We use multiple data providers to ensure accuracy and completeness of our historical data:

• Primary Source: Yahoo Finance API for price and volume data
• Backup Sources: Alpha Vantage and IEX Cloud for data validation
• Corporate Actions: Adjusted for stock splits, dividends, and spin-offs
• Data Frequency: Daily closing prices and volumes
• Historical Coverage: Data available from 2010 onwards

Backtest Assumptions

Our backtests make several assumptions that may not reflect real-world trading conditions:

Execution Assumptions

• No Slippage: Orders executed at exact closing prices
• No Transaction Costs: Zero commission fees assumed
• Perfect Liquidity: Unlimited shares available at market price
• Instant Execution: No delays in order processing
• No Market Impact: Large orders don't affect stock prices

Portfolio Assumptions

• Equal Weighting: Equal allocation to all selected stocks
• Monthly Rebalancing: Portfolio adjusted on first trading day of each month
• Cash Management: Uninvested cash earns no interest
• No Short Selling: Long-only strategy

Rebalancing Methodology

Our monthly rebalancing process follows these steps:

1. Data Collection: Gather latest price and volume data
2. Momentum Calculation: Calculate 6-month and 12-month returns
3. Stock Selection: Rank stocks by momentum score
4. Portfolio Construction: Select top N stocks (typically 10-20)
5. Equal Weighting: Allocate equal capital to each selected stock
6. Rebalancing: Sell all positions and buy new selections

Performance Metrics

We calculate several performance metrics to evaluate strategy effectiveness:

• Total Return: Cumulative percentage gain over the period
• Annualized Return: Average yearly return
• Volatility: Standard deviation of monthly returns
• Sharpe Ratio: Risk-adjusted return measure
• Maximum Drawdown: Largest peak-to-trough decline
• Win Rate: Percentage of profitable months

Limitations of Backtested Results

Backtested results have inherent limitations that investors must understand:

Data Limitations

• Survivorship Bias: Only includes stocks that survived the entire period
• Look-Ahead Bias: Uses information that wasn't available at the time
• Data Quality: Historical data may contain errors or gaps
• Corporate Actions: Complex corporate events may not be perfectly modeled

Market Limitations

• Market Regime Changes: Strategy may not work in all market conditions
• Capacity Constraints: Strategy may not scale to large capital amounts
• Competition: Other traders may exploit the same signals
• Regulatory Changes: New rules may affect strategy viability

Live Trading vs Backtesting

There are significant differences between backtested and live trading results:

Educational Purpose

This methodology is provided for educational purposes only. It demonstrates how momentum strategies can be constructed and tested, but should not be considered as investment advice. Always consult with a qualified financial advisor before making investment decisions.