How Effective Is Technical Analysis?

Technical analysis is the study of past price patterns to identify market trends and trading opportunities. Technical analysts believe that the collective actions of all participants in the market, including buyers and sellers, producers and consumers, investors and speculators, etc., influence asset prices. By analyzing price data, technical analysts aim to identify market trends and trading opportunities.

Technical analysis is a popular tool that is used to identify trading and investment opportunities. But how effective is it? Can trading based on technical analysis beat buy and hold?

Reference [1] provided a short survey of the current research on the effectiveness of technical analysis.

Technical trading strategies may be profitable because of noise in the market or investors' irrational behaviour, yet conventional efficient market theories, such as the martingale model and random walk models, exclude technical trading profits in speculative markets. The last section surveys empirical studies. By analyzing the testing procedures used in the studies, we categorize "early" and "modern" studies. Of the 58 studies that produced positive results, 24 produced negative results. The remainder produced mixed findings. Despite the fact that several empirical studies have shown that technical trading strategies can be profitable over a long period of time, the majority of test procedures have significant limitations, such as data snooping, the ex-post choice of trading rules or search engines, and the inability to estimate transaction costs and risks. To prove that technical trading strategies are profitable, researchers will need to correct these shortcomings in testing.

We agree with the author that there are limitations in the current publication regarding technical trading strategies. The study results are mostly inconclusive and it is difficult to find strong evidence that technical trading strategies outperform buy-and-hold.

Let us know what you think in the comments below.

Reference

[1] Roopali Patil, An Overview of Technical Analysis as a Trading tool, SPECIALUSIS UGDYMAS / SPECIAL EDUCATION 2022 1 (43)

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