Technical Analysis - What Works?
Spring has arrived and Sunday mornings are once again reserved for football. A few more years and it will be the senior league for me, although technically I think I qualify now. After each game, I generally require a beer to wash down a couple of tylenol pills and ice packs strapped to my ankles and knees to assist in minimizing any inflammation. Since I can't move, this is usually a good time to park myself on the couch and catch up on some easy reading.
Today's easy reading includes a summary of a paper written by Nauzer Balsara, Jason Chen, and Lin Zheng which was published in the Journal of Asset Management, vol. 10, no. 2(June 2009):97-123 titled 'Profiting from a Contrarian Application of Technical Trading Rules in the US Stock Market' (The summary can be found in CFA Digest, November 2009, vol. 39, no. 4). Technical Analysis is an important part of our investment management process, but there is an ongoing debate as to whether or not it adds any value in identifying trading opportunities as opposed to just buy-and-hold (a. k. a. buy-and-hope). As part of a process that includes both quantitative and fundamental analysis within a core/satellite investment strategy, we think technical analysis adds/protects a lot of value.
In this case, the authors first investigate whether the DJIA, NASDAQ and S&P500 follow a random walk (if so,this should make it difficult for technical analysis to work). Next the authors define their trading rules for 3 technical strategies: moving average crossover, trading range breakout and Bollinger bands. For each case, the authors evaluate the regular and contrarian application of the rules by using three performance metrics: average returns to all trades, probability of success, and payoff ratio.
The authors were not able to reject that the markets follow a random walk. What is interesting is that the contrarian application of the trading rules of all three technical strategies produced consistently positive excess stock returns relative to the buy-and-hold portfolio; however, when the conventional application did work, the payoff was high.
If you'd like to learn more about our investment management strategy and processes, give us a call.
GB
Today's easy reading includes a summary of a paper written by Nauzer Balsara, Jason Chen, and Lin Zheng which was published in the Journal of Asset Management, vol. 10, no. 2(June 2009):97-123 titled 'Profiting from a Contrarian Application of Technical Trading Rules in the US Stock Market' (The summary can be found in CFA Digest, November 2009, vol. 39, no. 4). Technical Analysis is an important part of our investment management process, but there is an ongoing debate as to whether or not it adds any value in identifying trading opportunities as opposed to just buy-and-hold (a. k. a. buy-and-hope). As part of a process that includes both quantitative and fundamental analysis within a core/satellite investment strategy, we think technical analysis adds/protects a lot of value.
In this case, the authors first investigate whether the DJIA, NASDAQ and S&P500 follow a random walk (if so,this should make it difficult for technical analysis to work). Next the authors define their trading rules for 3 technical strategies: moving average crossover, trading range breakout and Bollinger bands. For each case, the authors evaluate the regular and contrarian application of the rules by using three performance metrics: average returns to all trades, probability of success, and payoff ratio.
The authors were not able to reject that the markets follow a random walk. What is interesting is that the contrarian application of the trading rules of all three technical strategies produced consistently positive excess stock returns relative to the buy-and-hold portfolio; however, when the conventional application did work, the payoff was high.
If you'd like to learn more about our investment management strategy and processes, give us a call.
GB
Labels: Technical Analysis
posted by Gordon Bell at
5:01 PM
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