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Technical analysis in the foreign exchange market

  • Christopher J. Neely
  • Paul A. Weller

This article introduces the subject of technical analysis in the foreign exchange market, with emphasis on its importance for questions of market efficiency. Technicians view their craft, the study of price patterns, as exploiting traders’ psychological regularities. The literature on technical analysis has established that simple technical trading rules on dollar exchange rates provided 15 years of positive, risk-adjusted returns during the 1970s and 80s before those returns were extinguished. More recently, more complex and less studied rules have produced more modest returns for a similar length of time. Conventional explanations that rely on risk adjustment and/or central bank intervention are not plausible justifications for the observed excess returns from following simple technical trading rules. Psychological biases, however, could contribute to the profitability of these rules. We view the observed pattern of excess returns to technical trading rules as being consistent with an adaptive markets view of the world.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2011-001.

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Date of creation: 2011
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Handle: RePEc:fip:fedlwp:2011-001
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  21. Gencay, Ramazan & Dacorogna, Michel & Olsen, Richard & Pictet, Olivier, 2003. "Foreign exchange trading models and market behavior," Journal of Economic Dynamics and Control, Elsevier, vol. 27(6), pages 909-935, April.
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  24. Hsu, Po-Hsuan & Hsu, Yu-Chin & Kuan, Chung-Ming, 2010. "Testing the predictive ability of technical analysis using a new stepwise test without data snooping bias," Journal of Empirical Finance, Elsevier, vol. 17(3), pages 471-484, June.
  25. Michael Dueker & Christopher J. Neely, 2006. "Can Markov switching models predict excess foreign exchange returns?," Working Papers 2001-021, Federal Reserve Bank of St. Louis.
  26. Christopher J. Neely & David E. Rapach & Jun Tu & Guofu Zhou, 2010. "Out-of-sample equity premium prediction: economic fundamentals vs. moving-average rules," Working Papers 2010-008, Federal Reserve Bank of St. Louis.
  27. Christopher J. Neely, 1998. "Technical analysis and the profitability of U.S. foreign exchange intervention," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 3-17.
  28. Thomas Oberlechner & Carol Osler, 2009. "Overconfidence in Currency Markets," Working Papers 02, Brandeis University, Department of Economics and International Businesss School.
  29. de Zwart, G.J. & Markwat, T.D. & Swinkels, L.A.P. & van Dijk, D.J.C., 2007. "The Economic Value of Fundamental and Technical Information in Emerging Currency Markets," ERIM Report Series Research in Management ERS-2007-096-F&A, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.
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  31. Michael P. Dooley & Jeffrey R. Shafer, 1976. "Analysis of short-run exchange behavior: March, 1993 to September, 1975," International Finance Discussion Papers 76, Board of Governors of the Federal Reserve System (U.S.).
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