had a strong influence on the forecasting power of the trading rules applied to the LIFFE cocoa futures price in Pounds. There is a dramatic change in predictability when the LIFFE cocoa futures price is transformed to Dollars. On the other hand the forecasting power of the strategies on the CSCE cocoa series transformed to Pounds is not as strong as the forecasting power of the strategies applied to the LIFFE cocoa series in Pounds. The Pound-Dollar exchange rate mechanism thus provides only a partial explanation, in addition to the demand-supply mechanism on the cocoa market, of the predictability of trading rules applied to cocoa futures.
2.7.2 What causes success and failure of technical trading?
An important theoretical and practical question is: ``What are the characteristics of speculative price series for which technical trading can be successful?'' In order to get some insight into this general question from our case-study, it is useful to plot the price and returns series all on the same scale, as shown in figure 2.4. The returns series clearly show that the volatility in the Pound-Dollar exchange rate is lower than the volatility in both cocoa futures series. Furthermore, the price series on the same scale show that the trends in the LIFFE cocoa series are much stronger than in the CSCE cocoa series and the Pound-Dollar exchange rate. One might characterize the three series as follows: (i) CSCE has weak trends and high volatility; (ii) LIFFE has strong trends and high volatility, and (iii) Pound-Dollar has weak trends and low volatility.Recall from section 5 that the performance of technical trading may be summarized as follows: (i) no forecasting power and no economic profitability for CSCE; (ii) good forecasting power and substantial net economic profitability for LIFFE, and (iii) good forecasting power but no economic profitability for Pound-Dollar.
Our case-study of the cocoa futures series and the Pound-Dollar exchange rate series suggest the following connection between performance of technical trading rules and the trend and volatility of the corresponding series. When trends are weak and volatility is relatively high, as for the CSCE cocoa futures series, technical trading does not have much forecasting power and therefore also cannot lead to economic profitability. Volatility is too high relative to the trends, so that technical trading is unable to uncover these trends. When trends are weak but volatility is also relatively low, as for the Pound-Dollar exchange rates, technical trading rules can have statistically significant forecasting power without economically significant profitability. In that case, because volatility is low technical trading can still pick up the weak trends, but the changes in returns, although predictable, are too small to account for transaction costs. Finally, when trends are