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Technical analysis on foreign exchange: 1975-2004


When neither commissions nor a benchmark in the form of indexation is introduced into the analysis, there is certain support for the eight simple rules of trading suggested by technical analysis. It is possible to obtain investment strategies that outperform the return of the index.

There is little evidence that these excess returns are compensation for bearing excessive risk, as the Sharpe index reports. In summary, retrospectively speaking, some of these techniques could have beaten the market. Why these results could be possible or persistent? Among others explanations: Meese and Rogoff (1983) showed that no existing exchange rate model could forecast exchange rate changes better than a “no-change” guess at forecast horizons of up to one year.

This was true even when the exchange rate models were given true values of future fundamentals like output and money. Neely (1997) suggest “Either explanation for extrapolative trading implies that bubbles may be produced by slow dissemination of private information into the market, coupled with extrapolative trading rules”. However, the problem is that most of these strategies require too many transactions and produces just marginal returns. When commissions for trading and indexation are included into the analysis, the best 30 historical strategies produce an excess of return of just 0.31% per roundtrip trade (buy and sell).

Moreover, results for the best six strategies for Australia, Japan, Switzerland and the UK show an average return in excess for roundtrip commissions of only 0.06%, 0.39%, 0.22% and 0.17% respectively. Results for Canada show a slightly better picture, there were two strategies that return more than 0.48% meanwhile the rest four have an average return of just 0.08%. Although some consider commissions of 0.05% for roundtrip transactions realistic (Levich and Thomas (1993); Osler and Chang (1995); Neely (1997)), only an investor that could have the ability to get very low commissions, low taxes, and high volumes would benefit of these techniques. So, the trader must reach equilibrium between the numbers of trades and the return that she/he expects to get.

There is, of course, an entire issue in leveraging and the cost of it. An interesting additional problem is that the investor has had the ability of to identify the proper characteristics of the technique, which seem to be different in each case because none of them is apparently better than the rest. In summary, results seem to be strong enough in favor of market efficiency. Out of 48 strategies studied for each pair, based in eight simple rules of trading, eventually just one or two seems to report enough excess return to pay roundtrip commissions and taxes.

Prof. F. Rubio

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