Optimization of technical trading strategies and the profitability in security markets

The ultimate goal of any testing strategy is to measure profitability. This paper measures the profitability of simple technical trading rules based on nonparametric models which maximize the total returns of an investment strategy. The profitability of an investment strategy is evaluated against a simple buy-and-hold strategy on the security and its distance from the ideal net profit. The predictive performance is evaluated by the market timing tests of Henriksson-Merton and Pesaran-Timmermann to measure whether forecasts have economic value in practice. The results of an illustrative example indicate that nonparametric models with technical strategies provide significant profits when tested against buy-and-hold strategies. In addition, the sign predictions of these models are statistically significant.  1998 Elsevier Science S.A.