Academic journal article Multinational Business Review

Validation of Moving Average Trading Rules: Evidence from Hong Kong, Singapore, South Korea, Taiwan

Academic journal article Multinational Business Review

Validation of Moving Average Trading Rules: Evidence from Hong Kong, Singapore, South Korea, Taiwan

Article excerpt

Abstract:

This paper tests two moving average technical trading rules for four Asian markets. Our results indicate that moving average rules do indeed have predictive power and can discern recurring price patterns for profitable trading. Moreover, our results support the hypothesis that technical trading rules can outperform the buy-and-hold strategy. Break-even one-way trading costs are estimated to be high for all four markets. To confirm the test outcome, robust tests based on bootstrap and the related t-tests among the markets are also carried out. We conclude from the statistical results that moving average rules are valid and indeed have predictive power. It is implied that the trading rules may be used to design a trading strategy that will beat the buy-and-hold strategy in the Hong Kong, Singapore, South Korea, and Taiwan markets. The contribution of the current study is that this is the first validation test of trading rules using four markets at a similar development stage and culture tradition; and in the tests, we use most current and longer periods than the periods used in previous literature. Our robust tests are unique and considered distribution-free.

INTRODUCTION

The purpose of this paper is to review the empirical evidence on the validation of moving average (MA) rules for four Asian markets: Hong Kong, Singapore, South Korea, and Taiwan, which are considered to be at a similar development stage. Rugman and Brain (2003, 2004) provide the analytical framework and proof for regionalized multinational enterprises and economies. Park (2005) shows that East Asian markets are in the process of financial integration. Economic and institutional research, such as Zhao et al. (2007), find that societal and cultural factors affect such regional and global linkages. If we can find some form of moving average rules that can predict changes in the stock index and then identify a trading strategy that will beat the buy-and-hold strategy, we could then assert that moving average rules are useful for predicting future stock market prices. This is the major contribution of this study.

Fama (1970) defines an efficient financial market as one in which security prices always fully reflect the available information; any new information will be quickly and instantaneously reflected in prices. Furthermore, since news on any company, by definition, is unpredictable (arrives randomly), price changes will be unpredictable or follow a random walk. The efficient market hypothesis (EMH) in its "weak-form" asserts that stock prices already reflect all information that can be derived by investigating market trading data such as the history of past prices and/or trading volume. Advocates of weak-form market efficiency hypothesize that investors cannot drive profits above a buy-and-hold strategy using any trading rule that depends solely on past market information such as price or volume, implying that technical trading rules are useless.

After more than three decades of research and literally thousands of journal articles, financial economists and practitioners have not yet reached a consensus on whether technical trading rules can discern recurring price patterns for profitable trading. The overwhelming majority of financial economists support the "weak-form" efficient market hypothesis. This is because much of earlier research supports the random walk hypothesis. Fama (1965) finds that stock prices indeed follow random walks and hence concludes that no systematic evidence supports technical trading strategies in the aspect of profitability. Van Horn and Parker (1967), using a simple technical trading rule for 30 NYSE securities, confirms the random walk hypothesis. Jensen and Benington (1970) conclude that technical trading rules are not useful. Other prominent studies done around the same time that support weak-form market efficiency include Larson (1960), Osborne (1962), Alexander (1964), Granger and Morgenstern (1963), Mandelbrot (1963), and Fama and Blume (1966). …

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