The Predictive Ability and Profitability of Moving Average Rules in the Saudi Stock Market

Abstract Following the implementation of capital market reforms, Saudi Arabia has opened up its stock market to international investors. This liberalisation has led to the inclusion of the stock exchange into leading global indices, which is expected to lead to an influx of foreign investment. Thus, it is important and timely to examine the efficiency of the Saudi stock market. To that end, this paper conducts a comprehensive investigation of the predictive ability and profitability of a popular trading rule, the moving average rule, using firm-level data for the Saudi stock market over the period 1st January 2008 to 31st December 2017. The results show that the moving average rule has predictive ability; the active rules for a majority of the sample companies outperformed the corresponding passive strategy. Furthermore, the results were economically significant as the rules were profitable even after the consideration of transaction costs. The results also showed that the most profitable moving average rules were those with short-moving average lengths, and that the introduction of a bandwidth, which serves to eliminate weak trading signals, had a positive impact on rule profitability. Importantly, the analysis showed that the most profitable component of the rule related to short selling as these trades resulted in higher profits than the long positions. A disaggregated analysis of sectors showed that the trading rules outperformed the buy-and-hold strategy in all seven industries considered, while the analysis of covariance revealed the importance of careful selection of filter size. Overall, the analysis documents significant inefficiencies in the Saudi stock market and suggests that the employment of a simple trading rule, based on past price data, can yield substantial profits across companies and sectors even in a costly trading environment. These findings suggest that the recent reforms that were implemented to improve the efficiency of the Saudi stock market have been suboptimal, and that further regulatory reform is required.