strong and volatility is relatively high, as for the LIFFE cocoa futures series, a large set of technical trading rules may have statistically significant forecasting power leading to economically significant profit opportunities. In that case, the trends are strong enough to be picked up by technical trading even though volatility is high. Moreover, since volatility is high, the magnitude of the (predictable) changes in returns is large enough to cover the transaction costs.
2.8 Concluding remarks
In this chapter the performance of a large set of 5350 technical trading rules has been tested on the prices of cocoa futures contracts, traded at the CSCE and the LIFFE, and on the Pound-Dollar exchange rate in the period 1983:1-1997:6. The large set of trading rules consists of three subsets: 1990 moving average, 2760 trading range break-out and 600 filter strategies. The strategies perform much better on the LIFFE cocoa prices than on the CSCE cocoa prices, especially in the period 1983:1-1987:12. In this period a large group of the trading rules applied to the LIFFE cocoa futures price has statistically significant forecasting power and is economically profitable after correcting for transaction costs. Applied to the CSCE cocoa futures series the trading rules show little forecasting power and are not profitable. The forecasting power of the strategies applied to the Pound-Dollar exchange rate in the period 1983:1-1997:6 is also statistically significant, but most trading strategies are not profitable.The large difference in the performance of technical trading in the LIFFE or CSCE cocoa futures contracts may be explained by a combination of the demand/supply mechanism in the cocoa market and the Pound-Dollar exchange rate. In the period 1983:1-1987:12 the price level of the cocoa futures contracts and the level of the Pound-Dollar exchange rate were, accidentally, strongly correlated. This spurious correlation reinforced upward and downward price trends of the LIFFE cocoa futures contracts in London, while weakening the price trends of the CSCE cocoa futures contracts in New York. For the LIFFE cocoa futures price series the trends are strong enough to be picked up by a large class of technical trading rules; for the CSCE cocoa futures price series most trading rules do not pick up the trends, which are similar to the trends in the LIFFE cocoa futures but weaker. We also performed a bootstrap analysis showing that benchmark models such as a random walk, an autoregressive and an exponential GARCH cannot explain the good performance of the technical trading rules in the period 1983:1-1987:12. However a structural break in the trend model cannot be rejected as explanation of the results. Apparently many technical trading rules are able to pick up this structural break in trend.