Can Individual Invesors Use Technical Trading Rules o Bea he Asian Markes? INTRODUCTION In radiional ess of he weak-form of he Efficien Markes Hypohesis, price reurn differences are found o be insufficien o develop rading rules o ake advanages of hisorical price paerns (Elon and Gruber, 1995, p. 402). Ye, raders coninue o use echnical analysis o esablish buy and sell decisions for various asses across markes. This sudy ses ou o deermine if here are consisenly profiable echniques ha can be applied for use in equiies markes and compare he echniques for marke-beaing reurns o raders who use hem. Traders, in his sense, represen individuals who acively manage heir posiions by holding shor-erm posiions. These aciviies conras o invesors who have a longer-erm invesmen horizon and are deemed more passive invesors, using wha is deemed a naïve buy and hold sraegy. The primary difference in perspecive is wheher aking advanage of shor-erm price movemens is more beneficial han long-erm price movemens. Technical analysis, in conras o fundamenal analysis of asses, looks a he curren price and relaes his o pas price hisory o deermine he iming of buying and selling of socks. The weak-form of he Efficien Markes Hypohesis saes ha sock prices conain all curren informaion owards valuing he company. Changes in prices resul from changes in he supply and demand for he sock. There are numerous rading echniques available and wih he increased usage of personal compuers and on-line daa services, he number and complexiy of hese echniques will surely increase o keep pace wih heir proponens. However, in he end, mos rading echniques are based on aking advanage of simple mahemaical rules based on he endency oward mean reversion. Simply saed, wha goes up mus come down (and in mos cases he reverse occurs as well). 1
PRIOR LITERATURE Of he academic work sudying he effeciveness of he various rading echniques available, mos focus on applying echnical analysis and ime-series ools o broad indices and no on individual equiies. Brock e al. (1992); Gencay (1996); Bessembinder and Chan (1998) and Kwon and Kish (2002) examine he reurns on US sock marke indices and find ha echnical rading provides posiive predicive power, in direc conflic wih he weak form of he Efficien Marke Hypohesis. More recenly, Wong e al. (2003); Ben-Zion e al. (2003) and Papahanasiou and Samias (2010) find ha raders can exploi poenial inefficiencies ha arise from smaller and hinner inernaional markes by using echnical rading rules. Seiler (2001) finds ha an opimal filer of he Relaive Srengh Index (RSI) rule provides for posiive reurns; however, his sudy only shows resuls for he RSI rule and for only illusraes is use on one sock. Anoher line of lieraure, Momenum Sraegy, focuses on he psychological aspec of rading. This sraegy assumes he paern of rading based on evens or economic daa will coninue for a period of ime. If paerns of reacion occur, hen sock prices do no follow a random paern, as has been saisically shown in he pas. Chan e al. (1996) and Hong and Sein (1998) find evidence of momenum rading wih regards o analyss earnings predicions and he subsequen earnings announcemens by firms. While momenum rading is similar in essence o echnical rading, i relies on announcemens and economic evens, while echnical rading sricly abides by mahemaical rules. The bulk of he echnical analysis lieraure bases iself on he apparen visual verificaion on an ex pos basis of he gain poenial of echnical rading (Elder, 1987; Sein, 1989; Arnold, 1994; Ezkhorn, 1995). Our sudy broadens he lieraure by looking a individual sock issues, expanding he sample o ha of socks of various size and he overall performance of sricly following echnical rading sraegies on an ex ane basis. DATA The sample of daa used in his sudy includes daily high, low and closing prices from he individual equiies ha comprised 17 various marke indices in Asian and Pacific Rim counries. The daa allows for a broad range of socks over a relaively long period of ime so ha prices will no be enirely subjec o specific evens or marke condiions. The sample period runs from December 31, 1995 hrough December 31, 2010. This exended ime period examined encompasses general marke expansions as well as he seep declines and recoveries from he currency crises of he lae 1990 s as well as he more recen financial crisis and global economic recession. We included he various markes in our sample o compare he rading performances of broadly-raded, high-volume lisings as well as hose ha have less deph and rading aciviy. 2
METHODOLOGY The rading echniques we employ are he arihmeic Moving Average (MA), he Relaive Srengh Index (RSI) and a Sochasic Oscillaor (K). These are among he more popular, general echniques used by echnical raders and he basis for many rading programs. The performance from using hese rading ools will be conrased agains a naive buy-and-hold sraegy over he same period. Arihmeic moving average: The arihmeic Moving Average is he arihmeic average of prices of a sock over he mos recen period of n days: MA n1 P i i0 n The Moving Average generaes a forecas from he pas prices of a securiy. A Moving average ha is increasing indicaes ha, on average over ime, prices are rending higher. The degree of sensiiviy for he echnique is deermined by he value of n, he number of days in he period. If n is oo small, here is oo much sensiiviy o changes in daily prices; if n is oo large, he Moving Average will no be sensiive enough. The rading signal generaed by he moving average is deermined when he curren price crosses he Moving Average line. If he curren day s closing price crosses o rade above he Moving Average line, ha generaes a buy signal o raders -- demand is currenly sronger han in he pas. If he closing price crosses o rade below he Moving Average line, demand is currenly weaker han in he pas and ha even generaes a sell signal o raders. Anicipaed rend performance of he moving average indicaor: The effeciveness of using he Moving Average for generaing a correc buy or sell decision can be anicipaed by looking a he dynamics of he Moving Average model iself: dma 0 dp One would expec, during a bull marke when equiies generally show higher prices, ha he Moving Average of prices would move accordingly higher, bu remain lower han he higherrending curren price. This is due o he Moving Average reaining prices from earlier in he ime period. Wihou any crossing of price lines and Moving Average lines, here would be no buy signals or sell signals ha he invesor could ac upon (hroughou our mehodology, we assume ha raders can only ac on each change of signal. This avoids over-accumulaing or over-borrowing shares in long or shor posiions. Similar rules hold for he Relaive Srengh Index and he Sochasic Oscillaor echniques). A similar, bu opposie, analysis would be observed during a bear marke. Thus, wihou periodic price changes, raders would no be able o ake advanage of he poenial long-erm gains ha less acive buy-and-hold invesors could enjoy during a susained rend. 3
Relaive srengh index: The Relaive Srengh Index for any rading day, RSI, was developed by J. Welles Wilder. This index value measures he srengh of prices for he mos recen period of n days, using he following formula: n1 U RSI *100 n1 n1 D U U is he average of he closing prices for hose days in which he price increases from he previous rading day during he period; D is he average of he closing prices for hose days in which he price declines from he previous rading day; ranges from 0-n-1. The index is on a 0-100 scale. An upward-rending sock would have a value approaching 100 and a downward rending conrac would have a value approaching zero. The perceived usefulness of he RSI is ha i shows rends or breakous sooner and/or more clearly han simple price charing-when he RSI is a a high level, he sock can be considered overbough and his would provide a signal for a rader o sell he sock (a sell signal), while a low RSI value would be considered an oversold condiion and his provide a signal for a rader o buy he sock (a buy signal). Anicipaed rend performance of he relaive srengh index: The effeciveness of he RSI during a rending marke can be anicipaed by looking a he effec of rising and falling prices have on he Index: RSI U RSI D 0, 0 In a bull marke, wih upward-rending prices, U would have dominance over D. The RSI of he sock would increase correspondingly, signaling more sells han buys. Acing upon his echnique would limi he gain in a rending equiy by selling oo soon. In a bear marke, D would have dominance over U. The RSI of he sock would decrease, signaling buys o a greaer degree han sells. Under ha seing, raders would end o buy before a sock booms ou. If he rader believes ha he RSI does signal he beginning of a new rend, hen he rading signals generaed by he Relaive Srengh Index would be appropriae. This corresponds o evidence of longer-erm mean reversion. Sochasic oscillaors: A Sochasic Oscillaor (he Oscillaor) compares he value of curren prices wih he range of prices during he n day rading period. The Oscillaor furher compares wo indices of price movemens o generae buy and sell signals; K, he index iself and Z, a moving average of he index: n1 n1 K P L i0 K *100, Z n1 n1 H L n In his index, H is he highes high and L is he lowes low for inraday prices during he period. From his, we observe a difference among he hree rading rules; he Sochasic Oscillaor akes ino accoun he inraday price movemens along wih he closing prices. A low value for K generaes a buy signal (an oversold condiion) and a high value for K generaes a i 4
sell signal (overbough). This is similar in naure o he RSI. Jus as wih he arihmeic Moving Average, K crossing Z signals a buy or a sell. Anicipaed rend performance of he sochasic oscillaor: The performance of he Sochasic Oscillaor wih respec o price movemens differs from he Relaive Srengh Index by including he price variable ino he formula. The range of prices is also imporan in deermining he value of K and Z: K K K Z 0, 0, 0, 0 P H L K Wihin a bull-rend, as more recen prices increase relaive o he range of rading, here is a sronger sell signal. However, as prices increase overall, here is some downward pressure in K. This is shown by he negaive influence of H. During a bear marke, he more recen prices generae a buy signal, bu his is counered by he influence of L. The Oscillaor also is sensiive o he magniude of he price range during he period. Price changes wihin a period of low volailiy are magnified. This creaes more rading signals han recen price sabiliy during a period of high volailiy. Tesing: The ess for his sudy will compare gains from he rading signals generaed by he Arihmeic Moving Average, he Relaive Srengh Index and he Sochasic Oscillaors. The gains from hese rules are hen compared wih a simple buy-and-hold sraegy for each of he socks in he sample. In conras, he passive invesor buys one share of each sock on January 3, 1996 (or, whenever rading began for he sock) and holds his invesmen unil December 31, 2010. The Moving Average rule will use 20, 100 and 200 day periods, o deermine if he lengh of n affecs he performance of he rule. The Relaive Srengh Index and he Sochasic Oscillaor will have wo separae sell levels, a 70 and a 80 and wo separae buy levels, a 30 and a 20. These will help deermine if he sricer filering of price movemens improves he resuls of hese rules. In addiion, n for he Relaive Srengh Index will vary; using 3, 9, 14 and 30 day periods; ha for he Sochasic Oscillaor (K), 9, 20, 100 and 200 day periods; for he Sochasic Oscillaor Moving Average (Z), 20, 100 and 200 day periods, for consisency o he Arihmeic Moving Average Rule. By abiding by he rading rules, we hope o deermine if a rader can inves in a mechanical, non-emoional fashion and ouperform he marke. If raders can use rading rules o ouperform a naive buy and hold invesmen sraegy, hen hese resuls provided some evidence ha conradics he weak-form of he efficien marke hypohesis. The implicaions on informaion coss and ime should be apparen. We ranslae he overall gains from each of he individual socks as being generally equivalen o buying one share of sock a eiher he sar of he sample period, as in he case of he buy-and-hold sraegy; or going long one share of sock on an iniial buy signal, or selling shor by borrowing one share of sock on an iniial sell signal. The average gains across each of he rading sraegies are equivalen o having a price-weighed porfolio wih one share raded in each sock upon he appropriae signal. Individual sock prices were adjused for splis. Gains are no adjused for dividends or commissions. 5
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