Empirical testing of the profitability of technical trading rules on growth and value stocks listed at the Nairobi securities exchange

Abstract

This study looked at the applicability of the most simple and commonly used technical trading rules when applied on growth and value stocks listed at the Nairobi Securities Exchange. The period under investigation goes from 2006 to 2010. A famous study conducted by Brock, Lakonishok and LeBaron in 1992 showed that technical analysis could indeed create abnormal profit compared to a buy and hold strategy. Later studies tested Brock et al’s results in the subsequent period from 1986 and onwards and reached the conclusion that the technical trading rules in question could no longer outperform a passive investment management strategy. This study is inspired by Brock et al’s 1992 study and uses simple moving average methodology to test the profitability of technical trading rules compared to buy-and-hold strategy. 5, 10 and 20 days simple moving average technical trading rules were tested using growth and value portfolios respectively. The earnings-to-price and book-to-market ratios were used to classify the stocks as growth or value stocks. The short moving average is the actual price and the long moving average varies in length from 5 to 20 days. The results are tested using the standard t-test which tests the equality of two means to test whether moving average technical trading rules outperform the buy and hold strategy. The results show that the trading rules are able to identify periods with positive and negative returns. For both portfolios the mean return following buy signals is negative for all trading rules while it is positive following a sell signal. Furthermore, sell periods are characterized by higher volatility than buy periods. This is consistent with the leverage effect. For the growth and value strategies, the 5, 10 and 20 days simple moving average trading rules did not generate a return that is above and statistically different from the buy and hold strategy. This confirms that the NSE is weak form efficient according to Fama (1970) efficient market hypothesis.