Success and failure of technical analysis in the cocoa futures market

A large set of 5350 trend following technical trading rules is applied to LIFFE and CSCE cocoa futures prices, and to the Pound-Dollar exchange rate, in the period 1983:1-1997:6. We find that 58% of the trading rules generates a strictly positive excess return, even when correcting for transaction costs, when applied to the LIFFE cocoa futures prices. Moreover, a large set of trading rules exhibits statistically significant forecasting power of the LIFFE cocoa futures series. On the other hand the same set of strategies performs poor on the CSCE cocoa futures prices, with only 12% generating strictly positive excess returns and hardly any statistically significant forecasting power. Bootstrap techniques reveal that the good results found for the LIFFE cocoa futures price series can not be explained by several popular null models like a random walk, autoregressive and GARCH model, but can be explained by a structural break in trend model. The large difference in the performance of technical trading may be attributed to a combination of the demand/supply mechanism in the cocoa market and an accidental influence of the Pound-Dollar exchange rate, reinforcing trends in the LIFFE cocoa futures but weakening trends in the CSCE cocoa futures. Our case-study suggests a connection between the success or failure of technical trading and the relative magnitudes of trend, volatility and autocorrelation of the underlying series.