History of share prices and market efficiency of the Madrid general stock index Massoud Metghalchi ⁎, Chien-Ping Chen 1 , Linda A. Hayes 2 School of Business Administration, University of Houston-Victoria, Victoria, TX 77901, United States abstract article info Article history: Received 10 August 2014 Received in revised form 11 March 2015 Accepted 13 May 2015 Available online 22 May 2015 JEL classification: G1 G12 Keywords: Technical analysis Trading indicators Market efficiency Buy and hold strategy We apply Moving Average (MA), Relative Strength Indicator (RSI), Moving Average Convergence Divergence (MACD), and trading breakout (TBO) techniques to investigate the weak-form market efficiency of the Madrid General Stock Index, Índice General de la Bolsa de Madrid (IGBM), from 1/2/1975 to 12/31/2012. The empirical results not only strongly validate the predictive power of trading rules with robust statistical significance in all three sub-periods over the thirty-eight years, but also provide the possible strategies to outperform the buy- and-hold strategy with the consideration of transaction costs and risk. This supports the argument against weak-form market efficiency of the IGBM. © 2015 Published by Elsevier Inc. 1. Introduction Technical analysis is the art of forecasting future prices based on past prices and volumes. Technicians have become more sophisticated by applying computer models that are based on various technical indica- tors to predict future prices. Technicians believe in the idea that prices move in trends and are determined by the changing attitudes of traders toward various economic, political and psychological forces. As Pring (1991) points out “the art of technical analysis, for it is an art, is to iden- tify a trend reversal at a relatively early stage and ride on that trend until the weight of evidence shows or proves that the trend has reversed.” The Efficient Market Hypothesis (EMH) asserts that stock prices already reflect all the available information, and technical analysis can- not be used to outperform a market buy-and-hold strategy. This asser- tion has been disputed among investors and researchers since Fama (1970). Empirically, in order to show the predictive power of technical analysis, researchers utilize historical stock price and volume informa- tion to confirm superior profitability of various trading rules over the buy-and-hold strategy. For testing the weak form of EMH, the Spanish stock market pro- vides an attractive target for our technical analysis. Founded in 1831, Bolsa de Madrid (Madrid Stock Exchange) provides an excellent setting of microstructures to test the profitability of trading rules. Since 1993, it has been one of the first stock markets to switch to all electric-trading. As noted by Yague and Gomez-Sala (2005), the Spanish stock market is a pure order-driven market with no market makers. Numerous types of orders can be executed electronically. The reminder of this article is divided into four sections. Section 2 contains the literature review. Data and methodology are described in Section 3. Section 4 presents empirical results of various technical trad- ing rules, followed by a comparison of strategies to beat the buy-and- hold strategy with transaction costs and risk. The final section provides concluding remarks. 2. Literature review Numerous early studies primarily test the “random walk” hypothesis to argue that investors cannot drive profits above a buy-and-hold strategy by using technical analysis that depends on past market information in- cluding price and volume. Listing a few studies from the 1960s, Larson (1960), Osborne (1962), Alexander (1964), Granger and Morgenstern (1963), Mandelbrot (1963), Fama (1965), Fama and Blume (1966), Van Horn and Parker (1967), and Jensen and Benington (1970) suggest the fu- tility of technical analysis. However, technical trading has been enjoying revitalization since the publication of three cornerstone-papers of Sweeney (1986), Lukac, Brorsen, and Irwin (1988), and Brock, Lakonishok, and LeBaron (1992). Sweeney (1986) applies various filter International Review of Financial Analysis 40 (2015) 178–184 ⁎ Corresponding author. Tel.: +1 281 275 8833. E-mail addresses: metghalchim@uhv.edu (M. Metghalchi), chenc@uhv.edu (C.-P. Chen), hayesl@uhv.edu (L.A. Hayes). 1 Tel.: 281 275 8811. 2 Tel.: 281 275 8854. http://dx.doi.org/10.1016/j.irfa.2015.05.016 1057-5219/© 2015 Published by Elsevier Inc. Contents lists available at ScienceDirect International Review of Financial Analysis