Hi guys! Andrea Unger here to talk about a back adjustment. What is back adjustment?
You know, I work on futures and futures have a duration, a limited life. Some happen to expire every three months, some are monthly, it depends on the instrument, on the market. What happens, then? If we compare, for example, crude oil, and we look at the quotes of June compared to July, we see that June may be is trading here and July is trading up there, at a certain distance, okay? This might be above, below, I don’t enter in these details because this is not the purpose of this video, but there’s a difference. Now, the moves are more or less similar because they’re the same commodity at the end of the day, but there is a difference. So when we decide to trade on the next expire, because there are higher volumes or for any reason, our chart will have June here and then all of a sudden July here, because we changed. And this gap here, that you can see here, is there on our chart and is not a real gap. If it is for example 0.5, which makes sense in crude oil, there has not been a real jump of 0.5. So if we use this chart, which makes sense because it’s the real price which we saw and traded, if we make that moving average somewhere below somewhere, that moving average will take into account this gap, but this will false the calculation of the moving average because there’s not been a real gap there, so the moving average is not showing the real behavior of the market, because there hasn’t been any jump in the price there.
So what do we do, what do brokers and providers do? When they’re here, they take all the past data and they change the prices of the past so that these two points merge together and there’s no gap anymore. How do they do it? An easy way to do it is, “Oh, there’s a 0.5 gap? Perfect, I’ll add 0.5 to all the prices in the past. Or if this were here, they would subtract 0.5. Another way is to measure the ratio and to multiply. The addition is the simplest way, the variations at that moment, you can choose also, depending on the provider you have. What can the problems be? This is a solution if you build trading systems when you need a relation between prices when you need to read the relation, the moving average, indicators… You have to do this. In some cases, if we have the next series below the previous one, it happens that if we go back in the past we might have negative prices. It happens, look at bonds and meats, there are situations where you have negative prices, and this is nonsense obviously, okay? So you work with charts that are no longer real and that have nothing to do with reality because there are evident mistakes, you cannot have negative prices. Not yet, at least.
And then, another point is that if you look at the past, at let’s say the historical top of the markets, okay? You have a price there, but has that price been back-adjusted? Let’s say it was 10 years ago, and every year for 12 times a year you had 0.5, for 10 years, you add a rough amount of over 10 points, so if this is the historical top, but that number will never be the real maximum price traded in the market. That number you see has never been touched because it is a number deriving from a mathematical operation. And this might be a problem depending on how you tend to use that information. So you must be aware of it. I do use back-adjusted prices, I have a feed provider adjust prices for me, I have to reload all past data whenever they’re adjusted because I have them on my client, I have to cancel all the data, if it’s on the server I just have to reload the charts and then add the back-adjusted prices, but you have to be aware. You want to use it because you need it for your trading system? Perfect. Be aware you might have negative data, and most importantly, levels that have never really been touched in the market.
This is it, stay tuned for more stuff. Ciao da Andrea Unger.
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