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Skewness preference and the popularity of technical analysis

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  • Ebert, Sebastian
  • Hilpert, Christian

Abstract

We propose a simple model of how investors evaluate a trading rule, and show that the market timing of technical trading rules induces lottery-like trading profits. Therefore, investors’ preference for positive skewness caters to the popularity of technical analysis. Since prospect theory implies strong skewness preference, it can explain why investors trade extensively on chart patterns that are meaningless in light of the efficient market hypothesis. Technicians often invoke behavioral finance as its theoretical foundation. Contrary to this view, we show that ideas from behavioral finance explain why technical analysis is popular despite the lack of theoretical foundation and empirical success.

Suggested Citation

  • Ebert, Sebastian & Hilpert, Christian, 2019. "Skewness preference and the popularity of technical analysis," Journal of Banking & Finance, Elsevier, vol. 109(C).
  • Handle: RePEc:eee:jbfina:v:109:y:2019:i:c:s0378426619302493
    DOI: 10.1016/j.jbankfin.2019.105675
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    More about this item

    Keywords

    Behavioral economics; Moving average; Prospect theory; Skewness preference; Technical analysis;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty

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