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Technical analysis that works

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A review of technical analysis in academic literature and in practice

Published in: Business
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Technical analysis that works

  1. 1. Technical Analysis That Works Useful trading tool or oxymoron? Disclaimer: This is Tom’s opinion, not FactorWave’s. This isn’t investment advice. The data and charts are full of lies and biases. You can lose lots of money. If you invest based on this talk you will become homeless and your spouse will leave you and your dog will run away.
  2. 2. What is Technical Analysis?
  3. 3. Working Definition Technical Analysis uses data derived from quotes and trades to predict prices. Examples: ● Stuff that is mostly nonsense: ○ “Traditional” indicators - MACD, RSI, “Stochastic” oscillator ○ Chart patterns - Head & Shoulders, Double Top, Ascending Triangle ○ Lots more ● Stuff that mostly works: ○ Momentum - Cross sectional and Time Series ○ The Low Beta anomaly ○ Term structure trades ○ GARCH (technically predicts volatility rather than prices) ○ Order book signals ○ Lots more
  4. 4. Charting - Mostly nonsense (but maybe not completely…?) https://finviz.com/screener.ashx?v=210&s=ta_p_headandshoulders
  5. 5. Technical analysis: Momentum Two types of momentum: ● Cross-sectional ○ Well-studied ■ Cliff Asness’s U of C thesis “Variables that Explain Stock Returns”, 1994 ■ “Momentum Strategies”, Chan (UIUC), Jagadeesh (Emory), Lakonishok (NBER), 1995 ■ “Value and Momentum Everywhere”, Asness, Moskowitz, Pedersen 2012 ■ About a zillion other papers ● Time Series ○ Distinct from cross-sectional momentum ○ Well-known in futures (“Time Series Momentum”, Moskowitz, Ooi and Pedersen 2011) ○ Also exists in equities (“The Enduring Effect of Time-Series Momentum on Stock Returns Over Nearly 100-Years”, D’Souza, Srichanachaichok, Wang, Yao 2016)
  6. 6. Let’s make a zillion dollars with momentum ● Take our universe of stocks ● Sort them by their returns over the past year ● Split them into deciles ● Go long the top decile, short the bottom decile, equal weight within deciles ● Rebalance every day ● We’re cheating a lot, this should be great!
  7. 7. Oh, that’s kind of awkward...
  8. 8. What happened? Value and Momentum Everywhere: “We examine value and momentum portfolios of individual stocks globally across four equity markets: the United States, the United Kingdom, continental Europe, and Japan. The U.S. stock universe consists of all common equity in CRSP (sharecodes 10 and 11) with a book value from Compustat in the previous 6 months, and at least 12 months of past return history from January 1972 to July 2011. We exclude ADRs, REITs, financials, closed-end funds, foreign shares, and stocks with share prices less than $1 at the beginning of each month. We limit the remaining universe of stocks in each market to a very liquid set of securities that could be traded for reasonably low cost at reasonable trading volume size. Specifically, we rank stocks based on their beginning-of-month market capitalization in descending order and include in our universe the number of stocks that account cumulatively for 90% of the total market capitalization of the entire stock market. This universe corresponds to an extremely liquid and tradeable set of securities. For instance, over our sample period this universe corresponds to the largest 17% of firms on average in the United States. For the U.S. stock market, at the beginning of the sample period (January 1972) our universe consists of the 354 largest firms and by the end of our sample period (July 2011) the universe comprises the 676 largest names. Hence, our sample of U.S. equities is significantly larger and more liquid than the Russell 1000.”
  9. 9. AQR’s Momentum Returns
  10. 10. Time Series Momentum ● Don’t worry about sorting ● Just buy stuff that’s gone up! ● Diversification is key ● http://www.factorwave.com/strategies/diversified_futures.html
  11. 11. Is Charting Nonsense? “Foundations of Technical Analysis: Computational Algorithms, Statistical Inference, and Empirical Implementation”, Lo, Mamaysky, and Wang. Journal of Finance 2000. 890 citations “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.” https://www.cis.upenn.edu/~mkearns/teaching/cis700/lo.pdf

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