Title: Profitability of Mechanical
Trading
Rules Application of Standard Deviation Model, BBZ, on Kuala Lumpur
Composite Index
Futures
Abstract: This paper reviews the evidence on
the
profitability of mechanical trading rules based technical analysis,
using selected tests to challenge the belief that successive price
movements are random. This paper reports on empirical tests that
mechanical
trading rules can generate abnormal returns above that of buy and hold
strategy
for FKLI, FCPO, Nikkei Futures and Hang Seng Futures over different
periods.
The test methods used are extensions of those used by Brock,
Lakonishok,
and LeBaron (1992). This study extends to include a newly constructed
mechanical
trading model, BBZ, using standard deviation bands. The basic
principles
in this trading model are moving averages and standard deviations as
advocated
by technical analysis. The prices and daily returns do not result in
normal Gaussian bell shape curves, suggesting that they are not random.
This paper
proposes that BBZ tries to capture large price movements which happen
beyond
1 standard deviation from the average. The mechanical buy signal
is above + 1 standard deviation and the mechanical
sell signal is below –1 standard deviation. Using daily data from 1995
to
2004 for FKLI, the net profit (after transaction costs) for BBZ is 688
index
points, which is better than buy and hold strategy (loss of 90 index
points). Similarly, positive returns are found for daily data
sample of 250 trading
days in 2004 for FCPO (267), Hang Seng futures (1,910) and Nikkei
futures
(1,339).
Authors: Noor Azlinna Azizan and Jacinta
Chan
Phooi M'ng
