Are technical investment strategies driven by chance? Hermes Quantitative Equities’ new research program seeks logic in chartists’ work, says Lewis Grant, portfolio manager.

Getting technical: We have developed a new and proprietary research program aiming to identify successful technical investment strategies. QTATE, our Quantitative Technical Analysis Testing Engine, examines techniques that aim to exploit observed patterns in stock-price movements. If we find a pattern with a logical basis and predictive power, we may build a short-term trading model to capitalise on it as part of our broader strategy.

First test: We used QTATE to assess a common moving-averages strategy, which uses the 50-day and 200-day mean prices of stocks to inform trading decisions. Stocks are bought when their 50-day, or fast, average price surpasses the 200-day, or slow, average and are sold when they fall below this level. Similar to a price-momentum strategy, it purchases stocks when prices begin to improve and divests as they start to decline. For simplicity, the results of applying it to the MSCI World Index are shown below (see chart 1).

The MSCI World Index and moving averages¹

First findings: In trending markets, the strategy shows strong potential. In mid-2009 it identified a market rally of more than 20%, our back tests show. It would have outperformed a buy-and-hold index-tracking fund in the last 20 years primarily because sell signals were generated early in the aftermath of both the dotcom bubble and the financial crisis, avoiding many of the losses (see chart 2). However, while these results look impressive, we advise investors to be cautious: the past is not necessarily a guide to the future, and QTATE's analysis suggests that these results are not strong enough to be considered statistically significant.

Cumulative return of a moving-averages strategy¹

Future tests: Irrational. Witchcraft. These terms arise during Hermes Quantitative Equities’ internal debates about technical strategies. The team, however, usually concludes that they can be highly effective. QTATE enables us to test the viability of multiple techniques involving many stocks. We will determine which add value in different markets and whether they can contribute to risk-adjusted, long-term outperformance.

Click here to read the April edition of The Measure, the monthly newsletter from Hermes Quantitative Equities.