Technical Analysis and Exchange Rate Dynamics

The study investigates the profitability and price effects of 1024 moving average and momentum models in the DM/dollar market (1973-1999) as well as in the yen/dollar market (1976-1999). The main results are as follows: First, each of these models would have produced a positive return over the entire sample period. Second, this profitability is exclusively due to the exploitation of persistent exchange rate trends. Third, these results do not change substantially when technical currency is simulated over sub-periods. Fourth, the out-of-sample profitability of those models which performed best in sample is slightly higher than the average in-sample profitability of all models; however, the ex-post best models perform much worse out of sample than in sample. Fifth, the aggregate transactions and positions of technical models exert an excess demand pressure on currency markets. Sixth, there is a strong feedback mechanism operating between exchange rate movements and the transactions triggered off by technical models. A rising exchange rate, for example, causes increasingly more technical models to produce buy signals, which in turn strengthen and lengthen the appreciation trend.