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The profitability of the moving average strategy in the french stock market

The profitability of the moving average strategy in the french stock market. This paper studies the cross-sectional profitability of moving average timing portfolios in the French stock market over the period from January 1, 1995 to December 31, 2012. The results provide strong evidence that the moving average timing outperforms the buy-and-hold strategy with higher returns and less risk exposure.



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Journal of Economics and Development, Vol.16, No.2, August 2014, pp. 21-38

ISSN 1859 0020

The Profitability of the Moving Average
Strategy in the French Stock Market
Hung T. Nguyen
College of Business, Massey University, New Zealand
National Economics University, Vietnam
Email: nguyenthehung@neu.edu.vn
Hang V. D. Pham
Sobey School of Business, Saint Mary’s University, Canada
National Economics University, Vietnam
Hung Nguyen
College of Business, Massey University, New Zealand
University of Finance and Marketing, Ho Chi Minh City, Vietnam

Abstract
This paper studies the cross-sectional profitability of moving average timing portfolios in the
French stock market over the period from January 1, 1995 to December 31, 2012. The results
provide strong evidence that the moving average timing outperforms the buy-and-hold strategy
with higher returns and less risk exposure. On average, moving average portfolios generate an
abnormal return of 3.72% per annum and always perform better than buy-and-hold benchmark
portfolios across different lag length and volatility portfolios. Moreover, our results prevail after
we control for transaction costs.
Keywords: Technical analysis, moving average, cross-sectional profit.

Journal of Economics and Development

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Vol. 16, No.2, August 2014

1. Introduction

according to the survey of Taylor and Allen
(1992). In addition, recent studies find strong
evidence of the profitability of employing technical analysis (Brock, Lakonishok, and LeBaron, 1992; Hendrik Bessembinder and Kalok
Chan, 1998; Lo, Mamaysky, and Wang, 2000;
Todea, Zoicaş-Ienciu, and Filip, 2009; Vlad
Pavlov and Stan Hurn, 2012). Especially, Han,
Yang, and Zhou (2011) prove that the moving
average timing strategy substantially outperforms a corresponding buy-and-hold strategy.
Furthermore, Park and Irwin (2007) reviewed
the evidence on the profitability of technical
analysis in diversified markets since the early 1990s and report that a majority of modern
studies indicate the economic profit of technical trading rules.

For years, the profitability of technical analysis has been the subject of intensive studies.
Technical analysis, or the use of historical
data to forecast the future market movement,
has been a useful technique for investors and
brokers from the very beginning of financial
markets. Since technical analysis came into
practice before the existence of modern financial theory and thus lacks a theoretical framework, academic studies always cast doubt on
the effectiveness of using technical analysis
(Fama and Blume, 1966; Jensen and Benington, 1970; Isakov and Hollistein, 1999). Critics
of technical analysis base their arguments on
three main reasons. First, if the application of
technical analysis is proved profitable, it provides evidence against a well-known efficient
market hypothesis (EMH) which suggests that
investors cannot earn over-the-market returns
by observing the historical price, as the prices
fully reflect all available information and the
true value of securities (Malkiel and Fama,
1970; Isakov and Hollistein, 1999; Vlad Pavlov and Stan Hurn, 2012). Second, technical
trading rules heavily rely on graphical analysis,
and thus, lack precise rules to be fully investigated (Isakov and Hollistein, 1999). Finally,
early tests of technical analysis have provided
very poor evidence which deepen academics’
concerns over the effectiveness of technical
trading rules (Fama and Blume, 1966; Jensen
and Benington, 1970; Hendrik Bessembinder
and Kalok Chan, 1998; Isakov and Hollistein,
1999). However, investors often refuse to reject technical analysis, even if there is a skew
towards using technical analysis rather than
fundamental analysis at a shorter time horizon,
Journal of Economics and Development

In this paper, we extend the research of Han,
Yang, and Zhou (2011) to the French stock
market with the main interest being on the
cross-sectional profitability of using the moving average timing strategy. Our objective is to
seek a persuasive answer for the controversial
issue of whether technical analysis is profitable
in the French stock market or not. Further, if
technical analysis is profitable, how does the
moving average strategy outperforms a buyand-hold strategy? Previous studies provide
little evidence on the cross-sectional profitability of moving average trading rules, and to
our knowledge, there have not been any papers
differentiating the performance of moving average portfolios and the buy-and hold ones in
the French stock market. Our paper contributes
to the existing literature by examining the abnormal returns of volatility quintile portfolios
in the French stock market. Finally, we address
the serious problems of previous studies when
22

Vol. 16, No.2, August 2014

dealing with time-series data by robust testing.

of MAPs.

We use daily data from January 1, 1995 to
December 31, 2012. We first calculate the daily
return and standard deviation for all individual
stocks in the French stock market, then categorize these stocks into 5 increasing volatility quintile portfolios based on their standard
deviations. Among the 5 quintile volatility
portfolios, the 1st quintile portfolio contains
stocks with the lowest standard deviation and
the highest standard deviation stocks belong to
the 5th quintile portfolio. Once portfolios are
constructed, we calculate the return and standard deviation of quintile portfolios, the corresponding portfolio index level and the moving
average (MA) index. Following Han, Yang,
and Zhou (2011), the rule of trading is as follows: for each quintile portfolio, when today’s
price exceeds its 10-day moving average (MA)
price, we will buy or keep holding the portfolio
a day later; otherwise, we will invest in a risk
free asset (1-month French treasury bill). We
shed light on the difference in returns between
10-day MA timing portfolios and relative buyand-hold portfolios and define it as the return of
MA Portfolios (MAPs). We find that the moving average portfolio outperforms the buy and
hold portfolio in all subsamples by 3.38% to
13.57%. Moreover, the difference in return is
larger for medium and high volatility samples
than for low volatility ones. When we analyze
abnormal returns using CAMP alpha, we find
that the abnormal returns increase substantially across the quintile portfolios, ranging from
3.87% to 15.92% per annum. Furthermore,
market betas of MA portfolios are often smaller than that of volatility quintile portfolios, indicating the negative sign for the market betas

We address the robustness of the profitability of MAPs using several approaches. We first
consider different lag lengths for assessing a
complete performance of MA timing strategy.
We then estimate the holding days and trading
frequency of the strategy as well as the breakeven transaction cost. Finally, we examine the
profitability of MAPs in two equal sub-periods.
Overall, the abnormal returns and beta coefficients from the CAPM model in different lag
lengths as well as in sub-periods are highly
consistent with results of the previous tests.

Journal of Economics and Development

The rest of the paper is structured as follows.
Section 2 discusses the literature review. Section 3 reports the methodology and data description. Section 4 discusses the results of empirical analysis by providing summary statistics
and explanations for abnormal return. Section 5
examines robustness of the profitability of MA
timing strategy in several approaches. Section
6 provides concluding remarks and reports research limitations.
2. Literature review
Previous research about the profitability of
technical analysis provides different findings for
the existing literature. A number of studies on
technical analysis, including Fama and Blume
(1966) and Jensen and Benington (1970), conclude that technical trading rules are not profitable (Hendrik Bessembinder and Kalok Chan,
1998; Richard J. Sweeney, 1988). Critics of
technical analysis base their arguments on the
efficient-market hypothesis (EMH) developed
by Fama (1970) which suggests that investors cannot earn over-the-market returns in the
long run by observing the historical price, as
the prices fully reflect all available information
23

Vol. 16, No.2, August 2014

Similarly, Fifield, Power, and Knipe (2008),
in their research on the profitability of moving
average rules over 15 emerging and three developed markets in the period of 1989-2003,
conclude that technical analysis is even more
profitable in emerging stock markets. In their
research on the Australian stock market, Metghalchi, Glasure, Garza-Gomez, and Chien
Chen (2007) support the probability of technical trading rules and point out the break-even
one-way transaction cost ranges from 0.61 to
2.36%. Among studies of European markets,
Isakov and Hollistein (1999) confirm the profitability of simple technical trading rules on
Swiss stock prices and the profitability is limited for a particular group of investors when
taking into account the existence of transaction
costs. Hudson, Dempsey, and Keasey (1996)
find the same conclusion about the predictability of technical trading rules in UK markets.
Todea, Zoicas-Ienciu, and Filip (2009) investigate the profitability of the optimum moving
average strategy on the main European capital markets, including France, and support the
existence of abnormal returns using technical
analysis. This research, however, does not consider the serious problems that may arise when
dealing with time-series data, including data
snooping, robustness checks and estimation of
transaction costs that may significantly distort
the final performance of technical trading rules
(Park and Irwin, 2007). As previous studies
provide no evidence of the cross-sectional profitability of moving average trading rules, our
paper contributes to the existing literature by
examining the abnormal returns on volatility
quintile portfolios in the French stock market.
Furthermore, we address the serious problems

and true value of securities (Malkiel and Fama,
1970; Isakov and Hollistein, 1999; Vlad Pavlov
and Stan Hurn, 2012). Although EMH is considered as one of the greatest contributions of
twentieth century economics, it remains a controversial theory as the profitability of technical analysis is getting more and more support
from recent studies (Brock, Lakonishok, and
LeBaron, 1992; Hendrik Bessembinder and
Kalok Chan, 1998; Lo, Mamaysky, and Wang,
2000; Vlad Pavlov and Stan Hurn, 2012). More
specifically, Brock, Lakonishok, and LeBaron
(1992) provide strong support for technical
strategies by testing two of the simplest and
most popular trading rules: moving average
and trading range break on the Dow Jones Industrial Average. Similarly, Kwon and Kish
(2002) apply three popular technical trading
rules to the New York Stock Exchange (NYSE)
indices and find that technical trading rules are
profitable over various models when compared
to the buy-and-hold strategy. Especially, Han,
Yang, and Zhou (2011) successfully prove
that the moving average timing strategy substantially outperforms the corresponding buyand-hold strategy. Furthermore, Park and Irwin
(2007) review the evidence on the profitability of technical analysis in diversified markets
since the early 1990s and report that a majority
of modern studies indicate an economic profit
from using technical trading rules.
The evidence from the international market
is even more convincing. Gunasekarage and
Power (2001) analyse four emerging South
Asian capital markets and support that technical trading rules have forecasting ability in
these markets and moving average strategy
outperforms the naive buy-and-hold strategy.
Journal of Economics and Development

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Vol. 16, No.2, August 2014

where Pit (i = 1,…,5) is the portfolio index
and L is lag length. Following Brock, Lakonishok, and LeBaron (1992) and Han, Yang, and
Zhou (2011), we examine a wide range of moving averages (10, 20, 50, 100 and 200 days) to
comprehensively assess the effectiveness of
this strategy. The wide range of lag lengths
investigated in this paper overcomes the limitation of the research of Isakov and Hollistein
(1999) as these authors consider shorter lengths
for lag periods of 5, 10 and 30 days. In addition, we want to examine the performance of
moving average portfolios when the lag lengths
increase to 100- and 200-days.

of previous studies when dealing with time-series data by robustness testing. The following
sections will discuss the methodology of this
research in more detail.
3. Data and methodology
Among trading strategies using technical
analysis, moving average is one of the most
popular and widely used tools thanks to its
simplicity and ease of application in diversified markets. This paper tests the profitability
of the moving average strategy in the French
market with data extracted from Datastream
(DS) by using the method suggested by Han,
Yang, and Zhou (2011). Particularly, we first
calculate the daily return and standard deviation for all individual stocks in the French stock
market, then categorize these stocks into 5 increasing volatility quintile portfolios based on
their standard deviations. Among the 5 quintile
volatility portfolios, the 1st quintile portfolio
contains stocks with the lowest standard deviation and the highest standard deviation stocks
belong to the 5th quintile portfolio. Once portfolios are constructed, we calculate the return
and standard deviation of quintile portfolios
and the corresponding portfolio index level.
For all portfolios, we use equal weight for each
stock and hence, the return of each portfolio is
the average return of its individual stocks. We
test the sample period from January 1, 1995 to
December 31, 2012.

The idea of using moving average strategy is
based on the fact that financial series are volatile but follow certain trends (Isakov and Hollistein, 1999; Todea, Zoicaş-Ienciu, and Filip,
2009). According to this rule, investors should
hold a risky asset when its price witnesses a
continuously upward trend; otherwise, they
should invest in a risk free asset (Han, Yang,
and Zhou, 2011). Following the method suggested by Han, Yang, and Zhou (2011), we will
invest in the quintile portfolio i for trading day
t only if the closing price Pit-1 exceeds the moving average price MAit-1,L , otherwise we will invest in a risk free asset (1-month French Treasury bill). The return on moving average timing
strategy is illustrated by the following rules:

Secondly, we calculate the moving average
(MA) index by employing the model of Han,
Yang, and Zhou (2011). The MA at time t of
lag L is defined as the average price of the last
L days.

MAit , L =

Pit – L −1 + Pit – L − 2 + …+ Pit –1 + Pit
L

Journal of Economics and Development

 Rit , if Pit −1 > MAit −1, L , ;
R*it , L = 
( 2)
RF
otherwise
,
t
,

where Rit is the return on the i-th volatility
quintile portfolio on day t, R*it,L is the return on
MA timing portfolio with lag L and RFt is the
return on 1-month Treasury Bills at time t.

(1)
25

Vol. 16, No.2, August 2014

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