Some folks wrote to me concerning whether my back-testing models incorporate transaction costs. As of today, I kept the settings on transactions mostly default so I expect my models to over-estimate returns. To keep things safe, I always create a benchmark portfolio of equal-weighted STI stocks to compare investment return so that I do not get too carried away when I observe good back-test results.
In today’s article, we will look at transaction costs. And as it turns out, it is hard to perfectly simulate transaction costs into a back-testing exercise.
One of the most objective definitions of transaction costs is the difference between the cost of one share upon execution and the average between the bid price and ask price of a stock, so generally speaking, any of the following can increase your transaction costs.
a) Brokerage costs
Not all brokers are the same. For investors who really want …