Abstract
The paper explores the characteristics associated with the formation of bubbles that occurred in the Hong Kong stock market in 1997 and 2007, as well as the 2000 dot-com bubble of Nasdaq. It examines the profitability of technical analysis (TA) strategies generating buy and sell signals, with and without our proposed trading rules. The empirical results show that, by applying long and short strategies during the bubble formation and a short strategy after the bubble burst, it not only produces returns that are significantly greater than buy-and-hold strategies, but also produces greater wealth compared with TA strategies without trading rules. We conclude that these bubble detection signals help investors generate greater wealth from applying appropriate long and short moving average (MA) strategies.
Article PDF
Similar content being viewed by others
Avoid common mistakes on your manuscript.
References
Alexander, S. (1961) “Price Movements in Speculative Markets: Trends or Random Walks”, Industrial Management Review, Vol. 2, pp. 7–26.
—— (1964) “Price Movements in Speculative Markets: Trends or Random Walks?”, in P. Cootner, ed, The Random Character of Stock Market Prices, Vol. 2, Cambridge, MA: MIT Press, pp. 7–26.
Allen, H. and M. Taylor (1990) “Charts, Noise and Fundamentals in the London Foreign Exchange Market”, Economic Journal, Vol. 100, pp. 49–59.
Balvers, R. J., T. E. Cosimano and B. McDonald (1990) “Predicting Stock Returns in an Efficient Market”, Journal of Finance, Vol. 55, pp. 1109–1128.
Bessembinder, H. and K. Chan (1998) “Market Efficiency and the Returns to Technical Analysis”, Financial Management, Vol. 27, pp. 5–17.
Brealey, R. (1969) An introduction of Risk and Return from Common Stocks, Cambridge, MA: MIT Press.
Breen, W, L. R. Glosten and R. Jagannathan (1990) “Predictable Variations in Stock Index Returns”, Journal of Finance, Vol. 44, pp. 1177–1189.
Brock, W., J. Lakonishok and B. LeBaron (1992) “Simple Technical Trading Rules and the Stochastic Properties of Stock Returns”, Journal of Finance, Vol. 47, pp. 1731–1764.
Campbell, J. Y. (1987) “Stock Returns and Term Structure”, Journal of Financial Economics, Vol. 18, pp. 373–399.
—— and R. J. Shiller (1988a) “The Dividend–Price Ratio and Expectations of Future Dividends and Discount Factors”, Review of Financial Studies, Vol. 1, pp. 195–228.
—— and —— (1988b) “Stock Prices, Earnings and Expected Dividends”, Journal of Finance, Vol. 43, pp. 661–676.
Chan, R. H. F., H. S. T. H. Lee and W K. Wong (2014) Technical Analysis and Financial Asset Forecasting: From Simple Tools to Advanced Techniques, Singapore: World Scientific Publishing Company.
Chong, T. L. and W. K. Ng (2008) “Technical Analysis and the London Stock Exchange: Testing the MACD and RSI Rules using the FT30”, Applied Economics Letters, Vol. 15, pp. 1111–1114.
Conrad, J. and G. Kaul (1988) “Time-varying Expected Returns”, Journal of Business, Vol. 61, pp. 409–425.
Fama, E. F. (1965) “The Behavior of Stock-market Prices”, Journal of Business, Vol. 38, pp. 34–105.
—— (1970) “Efficient Capital Markets: A Review of Theory and Empirical Work”, Journal of Finance, Vol. 25, pp. 383–417.
—— and M. Blume (1966) “Filter Rules and Stock Market Trading Profits”, Journal of Business, Vol. 39, pp. 226–241.
—— and K. French (1988) “Dividend Yields and Expected Stock Returns”, Journal of Financial Economics, Vol. 22, pp. 3–25.
—— and —— (1989) “Business Conditions and Expected Returns on Stocks and Bonds”, Journal of Financial Economics, Vol. 25, pp. 23–49.
Farhi, E. and J. Tirole (2012) “Bubbly Liquidity”, Review of Economic Studies, Vol. 79, pp. 678–706.
Fisher, K. L. and M. Statman (2003) “Consumer Confidence and Stock Returns”, Journal of Portfolio Management, Vol. 30, pp. 115–127.
Fong, W M. and L. H. M. Yong (2005) “Chasing Trends: Recursive Moving Average Rules and Internet Stocks”, Journal of Empirical Finance, Vol. 12, pp. 43–76.
Frankel, J. and K. Froot (1990) “The Rationality of the Foreign Exchange Rate: Chartists, Fundamentalists, and Trading in the Foreign Exchange Rate”, American Economic Review, Vol. 80, pp. 181–185.
Friedman, M. (1953), in Essays in Positive Economics, Chicago: University of Chicago Press, pp. 205–227.
Hall, P. (1992) The Bootstrap and Edgeworth Expansion, New York: Springer-Verlag.
Harvey, C. (1995a) “The Cross-section of Volatility and Autocorrelation in Emerging Markets”, Finance Markets and Portfolio Management, Vol. 9, pp. 12–34.
—— (1995b) “Predictable Risk and Returns in Emerging Markets”, Review of Financial Studies, Vol. 8, pp. 773–816.
Hirano, T. and N. Yanagawa (2010) “Asset Bubbles, Endogenous Growth, and Financial Frictions”, CIRJE-F-752, Faculty of Economics, University of Tokyo.
Hudson, R., M. Dempsey and K. Keasey (1996) “A Note on the Weak Form Efficiency of Capital Markets: The Application of Simple Technical Trading Rules to UK Stock Prices – 1935 to 1994”, Journal of Banking and Finance, Vol. 20, pp. 1121–1132.
Isakov, D. and M. Hollistein (1999) “Application of Simple Technical Trading Rules to Swiss Stock Prices: Is it Profitable?”, Working paper, HEC, University of Geneva, Geneva.
Jensen, M. C. and G. A. Benington (1970) “Random Walks and Technical Theories: Some Additional Evidence”, Journal of Finance, Vol. 25, pp. 469–482.
Kung, J. J. and W. K. Wong (2009a) “Efficiency of the Taiwan Stock Market”, Japanese Economic Review, Vol. 60. pp. 389–394.
—— and —— (2009b) “Profitability of Technical Analysis in Singapore Stock Market: Before and after the Asian Financial Crisis”, Journal of Economic Integration, Vol. 24, pp. 133–150.
Lam, V. W. S., T. T. L. Chong and W. K. Wong (2007) “Profitability of Intraday and Interday Momentum Strategies”, Applied Economic Letters, Vol. 14, pp. 1103–1108.
Leung, M. J. and T. T. L. Chong (2003) “An Empirical Comparison of Moving Average Envelopes and Bollinger Bands”, Applied Economics Letters, Vol. 10, pp. 339–341.
Lo, A. and C. MacKinlay (1990) “When Are Contrarian Profits Due to Stock Market Overreaction?”, Review of Financial Studies, Vol. 3, pp. 175–205.
Lo, A. W., H. Mamaysky and J. Wang (2000) “Foundations of Technical Analysis: Computational Algorithms, Statistical Inference, and Empirical Implementation”, Journal of Finance, Vol. 55, pp. 1705–1764.
Mills, T. C. (1997) “Technical Analysis and the London Stock Exchange: Testing Trading Rules using the FT30”, International Journal of Finance and Economics, Vol. 2, pp. 319–331.
Mokhtar, S. H., A. M. Nassir and T. Hassan (2006) “Detecting Rational Speculative Bubbles in the Malaysian Stock Market”, International Research Journal of Finance and Economics, Vol. 6, pp. 102–115.
Neftci, S. N. (1991) “Naïve Trading Rules in Financial Markets and Wiener-Kolmogorov Prediction Theory: A Study of Technical Analysis”, Journal of Business, Vol. 64, pp. 549–571.
Ratner, M. and R. P. C. Leal (1999) “Tests of Technical Trading Strategies in the Emerging Equity Markets of Latin America and Asia”, Journal of Banking and Finance, Vol. 23, pp. 1887–1905.
Ready, M. (1997) “Pitfalls from Technical Trading Rules: Methods and Results”, Journal of Financial and Quantitative Analysis, Vol. 23, pp. 285–300.
Roberts, H. (1959) “Stock Market Patterns and Financial Analysis: Methodological Suggestions”, Journal of Finance, Vol. 14, pp. 1–10.
Schwager, J. (1995) Schwager on Futures: Technical Analysis, New York: Wiley.
Sweeney, R. (1988) “Some New Filter Rule Tests: Methods and Results”, Journal of Financial and Quantitative Analysis, Vol. 23, pp. 285–300.
Wong, W. K. and M. McAleer (2009) “Mapping the Presidential Election Cycle in US stock Markets”, Mathematics and Computers in Simulation, Vol. 79, pp. 3267–3277.
——, B. K. Chew and D. Sikorski (2001) “Can P/E Ratio and Bond Yield be used to Beat Stock Markets?”, Multinational Finance Journal, Vol. 5, pp. 59–86.
——, M. Manzur and B. K. Chew (2003) “How Rewarding is Technical Analysis? Evidence from Singapore Stock Market”, Applied Financial Economics, Vol. 13, pp. 543–551.
——, J. Du and T. T. L. Chong (2005) “Do the Technical Indicators Reward Chartists? A Study on the Stock Markets of China, Hong Kong and Taiwan”, Review of Applied Economics, Vol. 1, pp. 183–205.