Kwon 2002

The Quarterly Review of Economics and Finance 42 (2002) 611–631
A comparative study of technical trading strategies and

return predictability: an extension of Brock, Lakonishok,
and LeBaron (1992) using NYSE and NASDAQ indices
Ki-Yeol Kwon a , Richard J. Kish b,∗
a
American Express, New York, NY, USA
b
Lehigh University, 621 Taylor St., Bethlehem, PA 18015, USA
Abstract
This study extends the work of Brock et al.’s (1992) empirical analysis on technical trading rules
(price and momentum) by including trading volume moving averages; broader indices (New York Stock
Exchange (NYSE) and National Association of Security Dealers Automatic Quotations (NASDAQ))
covering both large-cap and small-cap firms using market weightings; and focusing on a time period that
includes great innovations in trading and disseminating data to the market. Similar to their study, we base
our conclusions on nonparametric analysis. By extending the t-test analysis through a residual bootstrap
methodology utilizing a random walk, a generalized autoregressive conditional heteroskedasticity in
mean (GARCH-M), and a GARCH-M with instrument variables, criticisms of earlier technical analysis
are mitigated. Overall, the results support Brock et al.’s (1992) price-weighted index (Dow Jones Indus-
trial Average (DJIA)) analysis by showing that the technical trading rules add value by capturing profit
opportunities when compared to a buy-and-hold strategy. When the analysis of the trading rules are ap-
plied to different time periods, the results reveal a weakening in profit potential over time. This may imply
that the market is becoming more efficient in disseminating information to a wider range of investors.
© 2002 Board of Trustees of the University of Illinois. All rights reserved.
JEL classification: E200, E270, G100
Keywords: Technical trading strategies; Return predictability; Indices
∗
Corresponding author. Tel.: +1-610-758-4205; fax: +1-610-758-6429.
E-mail address: rjk7@lehigh.edu (R.J. Kish).
1062-9769/02/$ – see front matter © 2002 Board of Trustees of the University of Illinois. All rights reserved.
PII: S 1 0 6 2 - 9 7 6 9 ( 0 1 ) 0 0 0 8 9 - 8
612 K.-Y. Kwon, R.J. Kish / The Quarterly Review of Economics and Finance 42 (2002) 611–631
1. Introduction
Market efficiency dictates that attempts by analysts to predict recurring price patterns are
futile because any information from analyzing past prices should already be reflected in the
current prices. Technical analysts disagree believing that some form of market inefficiency exists
in the form of sluggish responses from investors to new information. Due to this sluggishness,
technicians believe that price patterns from both public and private information can be used to
accurately predict changes in the supply and the demand for a security and thereby generate
profitable returns.
One of the motivations for this research is the contrast in the results of the prior literature.
Early attempts to “beat the market” with trading rules showed little success when empirical
tests accounted for transaction costs. But new models and testing procedures show promise
for successfully extrapolating future price movements using historical prices, trading volume,
and other market statistics. For example, Brock et al. (1992) provide empirical support for
utilizing technical strategies where returns from their trading strategies outperform not only a
buy-and-hold strategy but also several of the existing models: autoregressive (AR(1)), gener-
alized autoregressive conditional heteroskedasticity in mean (GARCH-M), and an exponential
GARCH.1 Since recent studies suggest that technical analysis on the predictability of equity
returns from past market information may have an economic value in contrast to earlier findings,
we investigate the value of technical trading rules focusing on the more “accurate” and valid
bootstrap methodology.2 This paper extends Brock et al. (1992), which utilized a price-weight
index (i.e., the Dow Jones Industrial Average (DJIA)), by testing the predictive ability of his-
torical data to forecast future prices for two distinct indices (i.e., the New York Stock Exchange
index, NYSE, and the National Association of Security Dealers Automatic Quotations index,
NASDAQ). Both indices cover a wider range of companies and are market weighted versus the
DJIA, which includes only 30 Blue-chip firms in a price-weighted format. In addition, the use
of the NASDAQ index extents the research to include stocks of small firms. Furthermore, we
provide additional empirical evidence that significant profit levels from trading rules, our proxy
for efficiency, indicate the existence of some inefficiency within the equity market. Thus our
contribution to the literature is to document the source of the conflict between the early (trading
rules cannot generate excess profits) and more recent empirical studies (some trading rules can
produce significant profitability). We also extend the finding of Brock et al. (1992) to include a
much broader market perspective, as well as, contrast the results from two distinct indices (i.e.,
the NYSE and NASDAQ indices). In addition, we validate the deterioration of trading rules
over time in two distinct markets over a variety of trading rules.
Both theoretical and empirical studies show mixed evidence of profitability from using tech-
nical trading rules. The theoretical development of trading models based on the predict-ability
of prices and returns using a noisy rational expectation model include Blume et al. (1994),
Brown and Jennings (1989), Diamond and Verrichia (1981), He and Wang (1995) and Hellwig
(1982). Early empirical studies of technical trading rules focused primarily on the infor-
mation derived from past prices failed to support the validity of trading rules (Alexander,
1961, 1964; Cootner, 1962; Fama & Blume, 1966; Van Horne & Parker, 1967, 1968). Recent
empirical studies, unlike many of the earlier works, tend to support the value of technical trading
rules (Brock et al., 1992; Neftci, 1991; Sweeney, 1988; Taylor & Allen, 1992).
K.-Y. Kwon, R.J. Kish / The Quarterly Review of Economics and Finance 42 (2002) 611–631 613
Models developed to account for the nonlinearity of prices include: GARCH-M, an exponen-
tial GARCH-M, and a multivariate GARCH-M, all of which can be tested using a bootstrapping
methodology.3 For example, Brock et al. (1992) investigate the profitability of trading rules ap-
plying the bootstrap methodology to three models: a random walk, GARCH-M, and exponential
GARCH-M over the period 1897–1986 for the DJIA. They find support for the nonlinear nature
of prices and returns and the profitability of technical trading rules.
2. Data and test statistics
2.1. Data
Both the NYSE and NASDAQ stock market value- and equal-weighted indices used in
the study are drawn from the tapes of the Center for Research in Security Prices (CRSP)
beginning with the first reporting of daily data, July 1, 1962 for the NYSE (8,685 daily obser-
vations) and January 2, 1973 for the NASDAQ exchange (6,066 daily observations) through
December 31, 1996.4 In addition to the full sample, three subsamples for the NYSE data
(7/1/62–12/31/72, 1/1/73–12/31/84, and 1/1/85–12/31/96) and two subsamples for the NAS-
DAQ data (1/1/73–12/31/84, and 1/1/85–12/31/96) are tested to determine if the value of the
trading rules dissipate overtime. The first subsample includes only NYSE index because of the
availability of data. Information variables include index prices, dividend yields, bond premiums,
term premiums and a dummy variable to test for the for January effect.5
In Table 1, the summary statistics for the entire sample period and the subperiods are compiled
for the daily returns of NYSE and NASDAQ indices. The summary statistics contain the distri-
bution characteristics: mean, variance, skewness, kurtosis, range, medium, interquartile range
(IQR), the Kolmogorov–Smirnov normality test statistic (D-stat), and Ljung–Box portmanteau
test statistics. Return is defined as the natural logarithm of value relatives, which is similar to
the arithmetic return for small values. Average returns for the NASDAQ value-weighted index,
0.00037, is higher than that of NYSE value-weight index, 0.00029. (Note that the average mean
return for the NYSE index over the comparable time period, 1973–1996 was also 0.00029.)
Equal-weighted returns are higher than value-weighted returns for both NYSE and NASDAQ
indices across all sample periods. All the unconditional means are significantly different from
zero, except the value-weighted NYSE and NASDAQ indices returns during the 1973–1984
period.
Most of the index return distributions show negative signs of skewness. In general, the sam-
ple kurtosis is higher than the kurtosis from a normal distribution. For the third subperiod,
1985–1996, the sample kurtosis of both value-weighted and equal-weighted index (i.e., 103.55
and 105.36, respectively) indicate violations of the normalcy assumption. The empirical dis-
tributions of most of the sample periods show thick tails. In other words, these returns for
both indices are highly leptokurtic for both full and subsample periods. Since all D-statistics
are close to zero, the Kolmogorov–Smirnov normality test reject a normal distribution of re-
turns. The first five auto-correlations are also reported. For the equal-weighted returns of NYSE
index, the auto-correlation even at lag 5, 0.07814, are higher than two times the Bartlett asymp-
totic standard error (Bart σ ) of 0.02146. The NYSE value-weighted returns are auto-correlated
only up to lag 1, which is greater than two times the Bart σ . For the NASDAQ index, the re-
turns are highly auto-correlated over lag 5. The high value of the representative Ljung–Box
portmanteau test statistics reported indicates that the samples are auto-correlated for both
indices.
2.2. Test statistics
We define the h day holding period return at time t as Rth = log(Pt+h ) − log(Pt ). Based
on price information up to and including day t, we classify the trading outcomes each day in
our sample as either a buy (b), sell (s), or neutral (n) signal. The mean return and variance
conditional on a buy (sell) signal over N periods can be written as
N−1
1
X̄b(s) = E(Rth |bt or st ) = Rt+1 Itb(s) (1)
Nb(s) t=0
N−1
1
σ̂(b)s
2
= E[(Rth − X̄b(s) ) |bt or st ] =
2
(Rt+1 − X̄b(s) )2 Itb(s) (2)
Nb(s) t=0
respectively, where Nb(s) is the number of total buy (sell) days, Rt+1 is daily return at time t + 1,
and Itb(s) is one for a buy (sell) signal observed at time t and zero otherwise. We test whether
the returns of any moving average trading rule is greater than a buy-and-hold strategy return
in terms of a “fair game” efficient model. The null hypothesis, H0 , claims that X̄r − X̄ = 0.
This is tested against the alternative hypothesis, HA , of X̄r − X̄ = 0, where X̄r and X̄ are the
mean return from the buy or sell trading rules and the unconditional (buy-and-hold) mean return
for each sample period tested.6 Since the t-test methodology assumes normality, stationarity,
and independent distributions, the interpretation of the results are suspect since the summary
statistics of Table 1 reveal that the return distributions are leptokurtic, auto-correlated, and
conditionally heteroskedastic. Also the mean returns of buy and sell signals are not independent
of the unconditional buy-and-hold returns.
2.3. Bootstrap analysis
To overcome the shortfalls of the t-test methodology within our test sample, the significance
of the technical trading rules are analyzed using a bootstrap methodology. There are several
advantages of using a bootstrap methodology. First, the bootstrap procedure is relatively robust
in terms of accounting for non-normality, autocorrelation, and conditional heteroskedasticity.
Second, unlike the traditional statistical methods, the bootstrap method allows us to avoid
the difficulty of deriving a test statistic for the significance of trading rules. Third, it permits
the estimation of standard deviations and confidence intervals for the estimators. Finally, the
bootstrap method allows us to simulate distributions of the trading rule returns by any specified
model.
To employ the bootstrap methodology, the residuals are randomly chosen with replacement
to generate the bootstrap return series based on the log difference of the prices. The three
trading rules (Moving Average-MAP , Moving Average with Momentum-MAP /MOROC , and
Moving Averages for price and trading volume—MAP /MAV ) discussed in the Appendix A are
analyzed within a bootstrapping using 500 replications.7 Estimates of the means, variances, test
statistics, and the empirical distributions of the bootstrap trading returns generated provide a
good approximation of the true return distribution. Similar to Brock et al. (1992) and Levich
and Thomas (1993), the distributions of the conditional moments for mean buy and sell returns
under the various trading rules using the bootstrap methodology are estimated. Under the three
models (random walk, GARCH-M, and GARCH-M with instrument variables), stock prices
and returns are forecasted.
The first model for bootstrap analysis is a random walk expressed as
ln Pt = ln Pt−1 + εt (3)
The natural logarithm difference of prices defined as a return is resampled with replacement.
The resampled or bootstrapped returns are exponentiated back to a bootstrapped price series
with the initial value of the stock price. The second model is a generalized autoregressive
conditional heteroskedasticity in mean model GARCH(1,1)-M defined as
Rt = β0 + β1 × Rt−1 + β2 × ht + εt (4)
√
where εt |Ωt−1 ∼ N(0, ht ), εt = vt × ht , and ht = α0 +α1 ×εt−1 2
+α2 ×ht−1 . The conditional
variance, ht , depends on the lagged squared residuals and lagged conditional variance. The error
term is conditionally normally distributed. The model estimates the direct effects of the volatility
on the returns and the impacts of the volatility on the returns are represented by the parameter
β 2 . Engle et al. (1987) estimate the GARCH-M model that allows the conditional mean return
to be a function of volatility.
The third model is a GARCH(1,1)-M with instrument variables
Rt = β0 + β1 × Rt−1 + β2 × JANt−1 + β3 × DYt−1 + β4 × TERMt−1

+ β5 × BONDt−1 + β6 × ht + εt (5)
where ε t and ht are as previously defined. The instrument variables include a dummy for the
January effect (JANt−1 ), dividend yields (DYt−1 ), term premium (TERMt−1 : the differences
between 6 and 3 month T-bill), and bond premium (BONDt−1 : the differences between 10- and
1-year T-bond). The variance equation is the same as that in the GARCH-M model. The model
estimates the impacts of the volatility on the returns through the parameter β 6 .
Table 2 contains estimation results for both GARCH-M models (GARCH-M in Panel A
and GARCH-M with instrument variable model in Panel B), that are later compared with the
actual NYSE and NASDAQ indices. The model contains AR(1) to capture the short hori-
zon auto-correlations. The results of the GARCH-M model are consistent with French et al.
(1987) who utilized the S&P index over the period 1928–1984. All instrument variables have
slight explanatory power to predict stock returns, which is also consistent with Fama and
French (1989) and Keim and Stambaugh (1986). The t-values, 2.79 for the parameter β 2 from the
GARCH-M model and 2.75 for the parameter β 6 from the GARCH-M with instruments model,
indicate that the conditional variance of stock returns is time varying and is auto-correlated. The
estimated parameters for the same variables, β 2 and β 6 , are 3.81 and 3.82, respectively. This
implies that a positive relationship exists between the conditional variance and the conditional
return. All coefficients in the variance equations are highly significant. The results are similar
for the NASDAQ index generated results.
3. Results
3.1. Random walk model
Because of the previously mentioned shortcomings of the traditional t tests, a 500 replication-
bootstrap methodology is utilized. Table 3a summarizes the results assuming a random walk
model using a driftless price for the full sample period for the NYSE and NASDAQ value-
weighted indices for our three trading rules (MAP , MAP /MOROC , and MAP /MAV ). The speci-
fications of three trading rules are reported in the first column of Table 3b and explained in the
Appendix A. In the second and third columns, “N(Buy) and N(Sell)” are the average number of
buy and sell signals over 500 bootstraps. The numbers in parentheses are the p-values that the
mean number of buy (sell) returns generated by simulations is greater than those generated by
the actual series. Smaller p-values are generally representative of simulations approximating
the actual values without the distribution shortfalls from non-normality, nonstationarity, and
nonindependence. In the fourth and fifth columns, the average standard deviations of buy and
sell returns (σ (Buy) and σ (Sell)) are presented. The results of mean buy, sell, and buy–sell
returns are reported in the column 6, 7, and 8, respectively. The simulated t-values are also
reported in the last three columns. We report the corresponding p-values in the parenthesis
under each value.
For the MAP and MAP /MOROC trading rules, the simulated mean numbers of buy and sell
signals are representative of the results generated with the traditional t test. For example, the
number of buys shown in Table 3a for the NYSE value-weighted index are 5,451 for MAP
and 3,475 for MAP /MOROC which correspond to 5,645 for MAP and 3,382 for MAP /MOROC
from the t-test results. The simulated number, 2,004, for the buy signals under the MAP /MAV
trading rule is significantly different from the actual value of 2,898. This implies that the trading
volume may have important information for forecasting returns. In other words, the random
walk model fails to capture the information from trading volume.
In general, the bootstrapped conditional standard deviations of mean buy and sell signals
for the random walk model are approximately equal to each other. This is contrasted with the
standard deviations reported using the traditional t test, where the buy standard deviations were
significantly less than the sell deviations. The bootstrapped random walk generated average
returns of buy signals with low probabilities of being greater than the actual returns. For example
the return generated by the simulated buy (0.00028) being greater than that of buy signals for
the actual series (0.00029) is only 5.3% for the NYSE value-weighted index. In contract, the
probabilities of the simulated average sell return being larger than those of the actual series are
quite high (99.5% for the NYSE value-weighted index). For all three trading rules, the simulated
average buy–sell returns are close to zero, which is much lower than the results generated using
the traditional t test. Supporting this trend, the t-values of the buy–sell decision are quite low
with the mean probability that the simulated buy–sell difference average returns are greater than
those of the actual price series are close to zero. This zero p-value for the simulated t-values of
buy–sell signal for all three tests (MAP , MAP /MOROC , and MAP /MAV ) implies that the random
walk model fails to replicate the actual price series. For example, the NYSE value-weighted
index show a probability of only 0.3%. Interesting the mean bootstrap returns for buys and
sells are close to the unconditional return, 0.00029, reported in Table 1. Again using the NYSE
value-weighted index as an example, the values are 0.00028 and 0.00030 for buys and sells,
respectively are approximately equal to the unconditional return of 0.00029.
Unlike the standard deviations in actual series, the simulated conditional standard deviations
for buys are approximately equal to that for sells. For example, the simulated mean standard
deviations for buy and sell signals on the MAP for the NYSE value-weighted index are 0.00829
and 0.00828, respectively. The simulated average conditional standard deviations for buys,
however, are greater than those reported for the actual series.
The results for MAP /MOROC trading rule are not much different from those for MAP trading
rule. When we consider combination moving average for price and trading volume (MAP /MAV ),
the random walk model fails to replicate not only the means and standard deviations, but also
the number of buys and sells, implying that the trading volume carries valuable information
about prices. In summary, the random walk model fails to replicate the means and variances
for buy and sell periods of technical trading rules for the NYSE and NASDAQ value-weighted
and equal-weighted indices over the test period. The results are essentially consistent with that
of Brock et al. (1992) who investigated DJIA index over 90 years, 1897–1986.
3.2. GARCH-M model
The bootstrap results on the GARCH-M model are summarized in Table 4a and 4b. For
the MAP and MAP /MOROC trading rules, the mean simulated average number of buy and sell
signals are not significantly different from the actual values. For instance, 6,395 and 2,155 for
MAP and 3,815 and 1,569 for MAP /MOROC using the NYSE value-weighted index correspond
to the t test values. While the simulated average returns of “Buy,” “Sell,” and “Buy–sell” rea-
sonably replicate the actual values, the simulated standard deviations of buy and sell signal
show an equalization between the two, that is, the standard deviations of the buys are higher
and the lows are smaller when compared to their actual counterparts. Similar to the actuals, the
GARCH-M model generates price series that the bootstrapped standard deviations for buys are
less than those for sells.
The average buy–sell spreads for MAP and MAP /MOROC trading rules from GARCH-M
model for the NYSE index, 0.00048, and 0.00071, are close to the actual ones, 0.00056 and
0.00085 while those are substantially larger than the same spread, −0.00003, and −0.00002,
from the random walk model, respectively. The simulated conditional standard deviations
0.00999, 0.01058, and 0.01000 of buy for MAP , MAP /MOROC , and MAP /MAV are much higher
than the actual ones, 0.00683, 0.00683, and 0.00640. For the MAP /MAV trading rule, the sim-
ulated p-values for the number of buy, “N(Buy),” are close to zero for all individual trading
rules. Furthermore, the discrepancies for sell returns are quite large, and the simulated p-values
are close to 100%, indicating that the differences are highly significant even at the 1% level.
Because of the overestimations of standard deviations and sell returns, the simulated mean
t-values, 1.807, 2.081, and 1.668 of buy–sell signals for MAP , MAP /MOROC , and MAP /MAV
trading rules are significantly less than the actual ones, 2.974, 3.559, and 5.526 at 5% level,
respectively. Like the random walk model, GACRH-M model ignores the information about
trading volume. The results show the strong evidence that the equilibrium price or return does
not fully reveal the information about the market.
In summary for all trading rules, the GARCH-M model fails to replicate the conditional stan-
dard deviations while it succeeds in replicating the conditional means for MAP and MAP /MOROC
trading rules. This result contradicts that of Brock et al. (1992) where they fail to replicate not
only returns, but also to match the results for volatility for the GARCH-M model. Furthermore,
when we consider trading volume data being available in public, the GARCH-M model is not
only able to replicate the conditional means, but also the conditional standard deviations. The
results are similar for the NASDAQ index also.
3.3. GARCH-M model with instrument variables
Table 5a and 5b shows the residual bootstrap test results for GARCH-M model with instru-
ment variables including dividend yield, term premium, bond premium, and a dummy variable
for the month of January. The mean simulated average number of buy and sell signals are
not significantly different from the actual values except the buy signal for the MAP /MAV . As
was the case of the GARCH-M model, the simulated average returns of “Buy,” “Sell,” and
“Buy–sell” replicate the actual one, but the simulated standard deviations of buy and sell sig-
nal do not. The t-values of buy–sell are significantly less than their actual counterparts. For
example, the mean simulated average number of buy signals, 6,352 for the MAP and 3,791 for
the MAP /MOROC are not significantly different from the actual ones, 5,645 for the MAP and
3,382 for the MAP /MOROC while 2,371 for the MAP /MAV is significantly less than the actual
number, 2,898. The simulated mean buy returns for the MAP , MAP /MOROC , and MAP /MAV
trading rules, 0.00095, 0.00117 and 0.00093, are close to the actual ones, 0.00047, 0.00073,
and 0.00060, respectively. The simulated conditional standard deviations 0.01030, 0.01095, and
0.01028 of buy for MAP , MAP /MOROC , and MAP /MAV are always higher than the actual ones,
0.00683, 0.00683, and 0.00640. The mean actual t-values of buy–sell returns, 2.974, 3.559,
and 5.526 are significantly higher than the simulated mean t-values, 2.087, 2.342, and 1.389
of buy–sell signal for the MAP , MAP /MOROC , and MAP /MAV trading rules, respectively for
the NYSE index. Similar comparisons are shown for the NASDAQ index also. Like both the
random walk model and GACRH-M model, the GARCH-M with instrument variable model
do replicate the standard deviations and t-values.
In summary, for all trading rules the GARCH-M and GARCH-M with instrument variable
models fail to replicate the conditional standard deviations while it succeeds in replicating
the conditional means for MAP and MAP /MOROC trading rules. This result contradicts that of
Brock et al. (1992) where they fail to replicate not only returns, but also to match the results
for volatility for the GARCH-M model. This may come from the difference in sample period
used. Our sample utilizes only post-WWII data (1962–1996) versus Brock et al. (1992) which
uses a time period with sectors of very thinly traded data (1897–1980). Furthermore, when we
consider trading volume data, both models are not only able to replicate the conditional means,
but also the conditional standard deviations.
4. Conclusions
In this extension of Brock et al. (1992), we investigate three popular technical trading rules
(moving average, moving average with momentum, and moving average with trading volume)
for two indices (NYSE and NASDAQ) over the period 1962–1996. Since the traditional t-test
statistics does not consider the dependencies between returns and assumes the normality of
return distribution, we focus our investigation on the significance of technical trading rules
using a residual bootstrap distribution of test statistics. We estimated the distributions of the
conditional moments for mean buy and sell returns assuming three models (a random walk
model, GARCH-M, and GARCH-M with instrument variables).
The results show that the technical trading rules have value to capture profit opportunities
over the buy-hold strategy. The buy, sell, and buy–sell returns generated from the random
walk model do not explain the returns of the MAP and the MAP /MOROC technical trading rules.
Although the returns obtained from both the GARCH-M model and GARCH-M with instrument
variables model by bootstrapping are likely to be close to returns of technical trading rules, the
simulated standard deviations are greater on the buy side and smaller on the sell side than
those of technical trading rules. When we consider trading volume for technical trading rules,
we show not only that the simulated number of buy under various null models, “N(Buy),” are
always less than those for all individual trading rules, but also that the discrepancies for sell
returns are quite large and highly significant even at 1% level. The results show that the return
series itself under various nulls does not fully reveal the information about the market. Thus, the
technical trading rules may capture nonlinear dependencies in the returns or relations between
returns and trading volume.
When we apply the same trading rules to the different subsamples, the results show a sig-
nificant weakening over time. Over the first and second period, 1962–1972 and 1973–1984,
the results are almost the same as that in the full sample. This ability to generate significant
profits, however, disappeared over the third period, 1986–1996, for NYSE index. Even in NAS-
DAQ index, the results of the last subperiod are slightly weaker than that in whole period.
This may imply that the market is becoming more efficient in disseminating information in
recent years because of the improvements in computer technology. In addition, this may ex-
plain that the value of technical trading rules is much higher in small stocks than that in large
stocks.
Notes
1. Blume et al. (1994) provide additional support for trading rules by showing that the
sequence of data for both past prices and trading volume improve the predictability of
equity returns within the “noisy rational expectation” frame-work. For other examples of
the efficiency literature see Brown and Jennings (1989), LeBaron (1991), Neftci (1991),
and Taylor and Allen (1992).
2. Although the traditional t-test methodology was undertaken for completeness, prior
research findings limit their validity. The t-test results are available upon request from
the authors. Also not shown, a complete analysis was undertaken for both the NYSE and
NASDAQ indices using both value- and equal-weightings, with and without dividends,
and with and without trading bands. Since the general trends are the same across the
different data sets, only the value-weight index without dividends and without trading
bands are shown. Results for the complete analysis across all data sets are available from
the authors upon request.
3. For instance, LeBaron (1991) examines simple moving average trading rules within the
currency spot and currency futures markets using bootstrap methods. Using a multi-
variate GARCH-M model, Karolyi and Kho (1994) find statistically significant profits
in the foreign exchange market trading, but conclude that the trading profits are fair
compensation for time-varying risk.
4. Since the data for NASDAQ series begins from 1973, we set the first subperiod, 1962–
1972, to match the subperiod for both NYSE and NASDAQ index. In addition, to keep
the same length of subperiod, we set the second and third subperiods as 1973–1984 and
1985–1996, respectively.
5. Dividend yield is defined as the dividend payment divided by price. The bond premium
is defined as the yield on the constant 10-year maturity U.S. Treasury bond less the yield
on constant 1-year maturity U.S. Treasury bond. And the term premium is defined as
the yield to maturity of long-term bonds less the yield of short-term securities on the
money market.
6. The t-statistic for returns of the buy (sell) moving average trading rules over the buy-and-
hold strategy is
X̄r − X̄
t=
σ̂r2 /Nr + σ̂ 2 /N
where X̄r , σ̂r2 , and Nr are the mean return, variance, and number of the buy or sell signals,
and X̄, σ̂s2 , and N are the unconditional mean, variance, and number of returns for the
entire sample period. For the buy–sell or the buy–sell spread, the t-statistic is
X̄b − X̄s
t=
σ̂b2 /Nb + σs2 /Ns
where X̄b , σ̂b2 , and Nb are the mean return, variance, and number of the buy signals, and
X̄s , σ̂s2 , and Ns are the mean return, variance, and number of the sell signals.
7. Like Brock et al. (1992) and Karolyi and Kho (1994) we employ the bootstrap method
developed by Efron (1979) and Freedman and Peters (1984). Efron and Tibshirani (1986)
show that the number of replications should be in the range of 500–1000, in order to
approximate the true estimator. In addition, we examine the sensitivity of our statistical
inferences to the choice of 500 replications. The simulated t-values for buy, sell, and
buy–sell return from 100 to 2,000 replications for (1, 150, 0) MA rule are analyzed.
Since there is little difference after 500 replications, we decide that 500 replications are
sufficient to estimate p-values for various simulated returns.
8. The band is used to reduce the amount of trading and therefore the trading costs. In
order to avoid the data mining problem, we test a variety moving average trading
rules. See Kwan and Kish (2001) for trading results of the NYSE case using
trading bands also. Since no significant differences were uncovered between the analy-
sis with and without trading bands, we show only the results without a trading
band.
9. According to Pring (1991), momentum is a generic term. So, momentum embraces many
different indicators such as rate of change (ROC), the relative strength indicator (RSI),
and moving-average convergence divergence (MACD). Momentum can be expressed as
the rate of increase or decline. The rate of declines or increases often slows ahead of the
final low or high (loss of momentum). Since the level of momentum is often as helpful
as its direction in assessing the quality of a price trend, it is important to use momentum
analysis in conjunction with some kind of trend-reversal signal (e.g., MA) in the price
series itself.
10. Since we set the moving average trading rule as 150 days, which can capture the in-
termediate or long-term trend, we focus on the short-term MA for momentum to cap-
ture the short-term trend. Thus, MA ROC is valued around increments of 100 days
or less.
11. Since the MA of price series is set as 150 days to capture the intermediate or long-term
trend, we choose short-term MA of volume to capture the short-term trends. See Pring
(1991) for additional justification.
Appendix A. Trading rules
Technical trading relies upon a fixed set of trading rules based on the behavior of returns
across time. For example, the moving average trading rule dictates a buy (sell) signal when the
shorter moving average, L1 , rises (drops) above (below) the longer average, L2 as shown in Eqs.
(A.1) and (A.2).
L −1 L −1
1 1
1 2
If Pt−i > Pt−j then Buy (A.1)

L1 i=0 L2 j =0
L −1 L −1
1 1
1 2
If Pt−i < Pt−j then Sell (A.2)

L1 i=0 L2 j =0
where Pt−i and Pt−j are prices at time t − i and t − j , respectively and L1 < L2 . To implement
the MAP for prices, we utilize L1 equal to 1 day and L2 ’s of 50, 100, 150 and 200 days with
and without a percentage band.8 For example, the trading rule, MAP (1, 50, 1) denotes that the
short MAP is 1 day, the long MAP is 50 days, and the band of the MAP is 1%. Thus, when the
1-day MAP is above (below) the 1% price band around the 50-day MAP , the buy (sell) signal
is generated at time t.
Since many technical analysts believe that momentum indicators capture the duration or
the turning point of a trend, the simple MAP is often combined with a momentum indicator,
MO.9 Utilizing the rate of changes (MOROC ) in prices to capture momentum, our MAP /MOROC
trading rule is expressed as

L −1 L −1 L −1 L −1
1 1
1 2
1 3
1 4
If Pt−i > Pt−j and ROCt−k > ROCt−k then Buy

L1 i=0 L2 j =0 L3 k=0 L4 k=0
(A.3)
L −1 L −1 L3 −1 L4 −1
1 1
1 2
1 1
If Pt−i < Pt−j and ROCt−k < ROCt−k then Sell
L1 i=0 L2 j =0 L3 k=0 L4 k=0
(A.4)
where L3 < L4 , ROCt−k is defined as [(Pt /Pt−k × 100) − 100] and k is the time span of the
momentum.
We utilize a MAP (1, 150, 0), a popular length utilized by traders, coupled with the momentum
rate of change (MOROC ), utilizing L3 = 1 and L4 = 25, 50, 75, and 100 days.10 For example,
the momentum trading rule for MOROC (1, 25, 150) denotes that the short MA for momentum
rate of change is 1 day, the long MA is 25 days, and the time span for the ROC is 150 days.
Thus, the combination moving average/momentum trading rule, MAP (1, 150, 0)/MOROC (1,
25, 150), denotes that when the 1 day MAP is above (below) the 150 day MAP and the 1 day MA
for the 150 day MOROC is above (below) the 25 day MOROC , the buy (sell) signal is generated
at time t.
Additionally trading volume is frequently used with the price moving average (whether MAP
or MAP /MOROC ) to confirm the buy or sell signal. For instance, suppose that the price MAP
and the simple L5 and L6 day moving averages of trading volume (MAV ) are constructed. This
combination of MAP /MAV , trading rule is expressed as
L −1 L −1 L5 −1 L6 −1
1 1
1 2
1 1
If Pt−i > Pt−j and Vt−n > Vt−m then Buy (A.5)
L1 i=0 L2 j =0 L5 n=0 L6 m=0
L −1 L −1 L5 −1 L6 −1
1 1
1 2
1 1
If Pt−i < Pt−j and Vt−n < Vt−m then Sell (A.6)
L1 i=0 L2 j =0 L5 n=0 L6 m=0
where L5 > L6 , Vt−i and Vt−j are the trading volume at time t − i and t − j , respectively and
the other variables are as previously defined.
To test the MA trading rules of both price and trading volume, we use MAP (1, 150, 0)
combined with volume moving averages where L5 = 1 and L6 = 5, 20, and 50, some of
the commonly used time spans for volume.11 For example, suppose that the combination
moving average trading rule is MAP (1, 150, 0)/MAV (1, 50, 0). When the 1 day MAP is
above (below) the 150 day MAP and the 1 day MAV is above (below) the 50 day MAV ,
both with a zero percentage band, then a buy (sell) signal is generated at time t. The general
rule is that a buy signal is generated when the MA for both price and volume are rising. A
sell signal is generated when the MA for price is falling with or without a falling MA for
volume.
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The Quarterly Review of Economics and Finance 42 (2002) 611–631

A comparative study of technical trading strategies and

JEL classification: E200, E270, G100

Keywords: Technical trading strategies; Return predictability; Indices

2. Data and test statistics

2.2. Test statistics

2.3. Bootstrap analysis

Rt = β0 + β1 × Rt−1 + β2 × JANt−1 + β3 × DYt−1 + β4 × TERMt−1

3.1. Random walk model

3.2. GARCH-M model

3.3. GARCH-M model with instrument variables

Appendix A. Trading rules

If Pt−i > Pt−j then Buy (A.1)

If Pt−i < Pt−j then Sell (A.2)

trading rule is expressed as

If Pt−i > Pt−j and ROCt−k > ROCt−k then Buy

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