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Foundations of Technical Analysis: Computational Algorithms, Statistical Inference, and Empirical Implementation

  • Andrew Lo

    ()

    (Massachusetts Institute of Technology)

  • Harry Mamaysky

    ()

    (Massachusetts Institute of Technology)

  • Jiang Wang

    (Massachusetts Institute of Technology)

Technical analysis, also known as "charting", has been a part of financial practice for many decades, yet little academic research has been devoted to a systematic evaluation of this discipline. One of the main obstacles is the highly subjective nature of technical analysis---the presence of geometric shapes in historical price charts is often in the eyes of the beholder. In this paper, we propose a systematic and automatic approach to technical pattern recognition using nonparametric kernel regression, and apply this method to a large number of US stocks from 1962 to 1996 to evaluate the effectiveness of technical analysis. By comparing the unconditional empirical distribution of daily stock returns to the conditional distribution---conditioned on specific technical indicators such as head-and-shoulders or double-bottoms---we find that over the 31-year sample period, several technical indicators do provide incremental information and may have some practical value.

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 1999 with number 402.

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Date of creation: 19 Mar 1999
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Publication status: Published, Journal of Finance, 55:4, August 2000, 1705-1765.
Handle: RePEc:sce:scecf9:402
Contact details of provider: Postal: CEF99, Boston College, Department of Economics, Chestnut Hill MA 02467 USA
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  1. Christopher J. Neely & Paul A. Weller & Robert Dittmar, 1997. "Is technical analysis in the foreign exchange market profitable? a genetic programming approach," Working Papers 1996-006, Federal Reserve Bank of St. Louis.
  2. C.L. Osler & P.H. Kevin Chang, 1995. "Head and shoulders: not just a flaky pattern," Staff Reports 4, Federal Reserve Bank of New York.
  3. Treynor, Jack L & Ferguson, Robert, 1985. " In Defense of Technical Analysis," Journal of Finance, American Finance Association, vol. 40(3), pages 757-73, July.
  4. Neftci, Salih N, 1991. "Naive Trading Rules in Financial Markets and Wiener-Kolmogorov Prediction Theory: A Study of "Technical Analysis."," The Journal of Business, University of Chicago Press, vol. 64(4), pages 549-71, October.
  5. Brock, William & Lakonishok, Josef & LeBaron, Blake, 1992. " Simple Technical Trading Rules and the Stochastic Properties of Stock Returns," Journal of Finance, American Finance Association, vol. 47(5), pages 1731-64, December.
  6. Neely, Christopher J. & Weller, Paul A., 1999. "Technical trading rules in the European Monetary System," Journal of International Money and Finance, Elsevier, vol. 18(3), pages 429-458.
  7. repec:cup:cbooks:9780521429504 is not listed on IDEAS
  8. Allen, Franklin & Karjalainen, Risto, 1999. "Using genetic algorithms to find technical trading rules," Journal of Financial Economics, Elsevier, vol. 51(2), pages 245-271, February.
  9. Blume, Lawrence & Easley, David & O'Hara, Maureen, 1994. " Market Statistics and Technical Analysis: The Role of Volume," Journal of Finance, American Finance Association, vol. 49(1), pages 153-81, March.
  10. Lo, Andrew W. & Mackinlay, A. Craig, 1997. "Maximizing Predictability In The Stock And Bond Markets," Macroeconomic Dynamics, Cambridge University Press, vol. 1(01), pages 102-134, January.
  11. Andrew W. Lo & A. Craig MacKinlay, 1987. "Stock Market Prices Do Not Follow Random Walks: Evidence From a Simple Specification Test," NBER Working Papers 2168, National Bureau of Economic Research, Inc.
  12. K. Geert Rouwenhorst, 1998. "International Momentum Strategies," Journal of Finance, American Finance Association, vol. 53(1), pages 267-284, 02.
  13. P.H. Kevin Chang & Carol Osler, 1994. "Evaluating chart-based technical analysis: the head-and-shoulder pattern in foreign exchange," Research Paper 9414, Federal Reserve Bank of New York.
  14. Jegadeesh, Narasimhan & Titman, Sheridan, 1993. " Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency," Journal of Finance, American Finance Association, vol. 48(1), pages 65-91, March.
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