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  • Technical Analysis in

    Financial Markets

  • ISBN 90-5170-679-0

    Cover design: Crasborn Graphic Designers bno, Valkenburg a.d. Geul

    This book is no. 305 of the Tinbergen Institute Research Series, established through

    cooperation between Thela Thesis and the Tinbergen Institute. A list of books which

    already appeared in the series can be found in the back.

  • Technical Analysis in

    Financial Markets

    ACADEMISCH PROEFSCHRIFT

    ter verkrijging van de graad van doctor

    aan de Universiteit van Amsterdam

    op gezag van de Rector Magnicus

    prof. mr. P.F. van der Heijden

    ten overstaan van een door het college voor promoties ingestelde

    commissie, in the openbaar te verdedigen in de Aula der Universiteit

    op maandag 3 maart 2003, te 13:00 uur

    door Gerwin Alfred Wilhelm Griffioen

    geboren te Amsterdam

  • Promotiecommissie:

    Promotores:

    Prof. dr C.H. Hommes

    Prof. dr H.P. Boswijk

    Overige leden:

    Dr J.J. van Duijn

    Prof. dr P.H.B.F. Franses

    Prof. dr F.C.J.M. de Jong

    Prof. dr B. LeBaron

    Dr ir F.O.O. Wagener

    Prof. dr H.N. Weddepohl

    Faculteit der Economische Wetenschappen en Econometrie

  • Acknowledgements

    This thesis is the result of four years of research as a Ph.D. student at the Center for

    Nonlinear Dynamics in Economics and Finance (CeNDEF) at the Department of Quan-

    titative Economics of the Faculty of Economics and Econometrics of the University of

    Amsterdam. During these past four years my bank account followed the stock market in

    its up and down swings. Luckily, the peaks and throughs in my research were steadily

    rising. This thesis would not have been written without the encouragement, help and

    support of numerous people, whom I like to thank here.

    First of all, I thank my supervisors Cars Hommes and Peter Boswijk. Without Cars I

    would never have started my Ph.D. in economics. He convinced me to start my career rst

    in academia instead of using my knowledge in business. I thank him for this opportunity.

    Next, I thank Peter for his interest in and many contributions to my research. I appreciate

    our regular meetings in discussing my work.

    I want to thank the other members of my Ph.D. committee, Jaap van Duijn, Philip

    Hans Franses, Frank de Jong, Blake LeBaron, Florian Wagener and Claus Weddepohl,

    for reading an earlier version of the manuscript.

    I thank my Italian Ph.D. colleague Sebastiano Manzan, with whom I shared an office

    and the frustrations of doing research for four years. Next I thank the people in the

    CeNDEF group, Jan Tuinstra, Cees Diks, Sander van de Hoog, Henk van de Velden and

    Roy van der Weide. Also I thank the many other people at the Department of Quantitative

    Economics, Frank Kleibergen, Dawit Zerom, Maurice Bun, Antoine van der Ploeg, Noud

    van Giersbergen, Angela van de Heerwaarden, Cees Jan van Garderen and Jan Kiviet. I

    thank the people of the cocoa-trading rm Unicom International B.V., Bart Verzaal and

    Guido Veenstra, for providing me the data used in Chapter 2 and for keeping me informed

    of all what was happening in the cocoa markets.

    Finally, I thank my mother and my father for always encouraging and supporting me.

    They gave me the opportunity to study at the university and I will always be grateful

    for that. Thanks to my sister Siemone, who followed me in studying econometrics, which

    caused many heavy debates when doing the dishes.

  • To my father and mother

  • Contents

    1 Introduction 1

    1.1 Financial practice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

    1.2 Technical analysis and efficient markets. An overview . . . . . . . . . . . . 10

    1.3 Outline of the thesis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

    2 Success and Failure of Technical Trading Strategies

    in the Cocoa Futures Market 33

    2.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

    2.2 Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

    2.2.1 Data series . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

    2.2.2 A continuous time series of futures prices . . . . . . . . . . . . . . . 37

    2.2.3 Summary statistics . . . . . . . . . . . . . . . . . . . . . . . . . . . 40

    2.3 Technical trading strategies . . . . . . . . . . . . . . . . . . . . . . . . . . 42

    2.3.1 The moving-average trading rule . . . . . . . . . . . . . . . . . . . 43

    2.3.2 Trading range break-out . . . . . . . . . . . . . . . . . . . . . . . . 45

    2.3.3 Filter rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45

    2.4 Performance measure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46

    2.4.1 Cocoa futures prices . . . . . . . . . . . . . . . . . . . . . . . . . . 46

    2.4.2 Pound-Dollar exchange rate . . . . . . . . . . . . . . . . . . . . . . 48

    2.5 Protability and predictability of trading rules . . . . . . . . . . . . . . . . 48

    2.5.1 The best 5 strategies . . . . . . . . . . . . . . . . . . . . . . . . . . 48

    2.5.2 The set of 5350 trading rules: economic signicance . . . . . . . . . 52

    2.5.3 The set of 5350 trading rules: statistical signicance . . . . . . . . . 53

    2.6 Bootstrap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59

    2.6.1 Bootstrap tests: methodology . . . . . . . . . . . . . . . . . . . . . 59

    2.6.2 Bootstrap tests: empirical results . . . . . . . . . . . . . . . . . . . 63

    2.7 Success and failure of technical trading . . . . . . . . . . . . . . . . . . . . 67

    2.7.1 The inuence of the Pound-Dollar exchange rate . . . . . . . . . . . 68

    ix

  • x

    2.7.2 What causes success and failure of technical trading? . . . . . . . . 71

    2.8 Concluding remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72

    Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

    A. Tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

    B. Parameters of technical trading strategies . . . . . . . . . . . . . . . . . 89

    3 Technical Trading Rule Performance

    in Dow-Jones Industrial Average Listed Stocks 93

    3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93

    3.2 Data and summary statistics . . . . . . . . . . . . . . . . . . . . . . . . . . 97

    3.3 Technical trading strategies . . . . . . . . . . . . . . . . . . . . . . . . . . 100

    3.4 Trading prots . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100

    3.5 Data snooping . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102

    3.6 Empirical results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106

    3.6.1 Results for the mean return criterion . . . . . . . . . . . . . . . . . 106

    3.6.2 Results for the Sharpe ratio criterion . . . . . . . . . . . . . . . . . 112

    3.7 A recursive out-of-sample forecasting approach . . . . . . . . . . . . . . . . 115

    3.8 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118

    Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120

    A. Tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120

    B. Parameters of technical trading strategies . . . . . . . . . . . . . . . . . 143

    C. Parameters of recursive optimizing and testing procedure . . . . . . . . 145

    4 Technical Trading Rule Performance

    in Amsterdam Stock Exchange Listed Stocks 147

    4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147

    4.2 Data and summary statistics . . . . . . . . . . . . . . . . . . . . . . . . . . 148

    4.3 Empirical results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150

    4.3.1 Results for the mean return criterion . . . . . . . . . . . . . . . . . 150

    4.3.2 Results for the Sharpe ratio criterion . . . . . . . . . . . . . . . . . 156

    4.4 A recursive out-of-sample forecasting approach . . . . . . . . . . . . . . . . 158

    4.5 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160

    Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164

    A. Tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164

    B. Parameters of recursive optimizing and testing procedure . . . . . . . . 184

  • xi

    5 Technical Trading Rule Performance

    in Local Main Stock Market Indices 187

    5.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 187

    5.2 Data and summary statistics . . . . . . . . . . . . . . . . . . . . . . . . . . 188

    5.3 Empirical results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 191

    5.3.1 Results for the mean return criterion . . . . . . . . . . . . . . . . . 191

    5.3.2 Results for the Sharpe ratio criterion . . . . . . . . . . . . . . . . . 199

    5.4 A recursive out-of-sample forecasting approach . . . . . . . . . . . . . . . . 202

    5.5 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205

    5.6 Comparing the US, Dutch and Other Stock Markets . . . . . . . . . . . . . 208

    Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 211

    A. Tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 211

    6 An Evolutionary Adaptive