Technical Analysis and Theory of Finance
Tsinghua University - School of Economics & Management
Washington University in St. Louis - Olin School of Business
September 17, 2007
EFA 2007 Ljubljana Meetings Paper
In this paper, we analyze the usefulness of technical analysis, specifically the widely used moving average trading rule, from an asset allocation perspective. We show that when stock returns are predictable, technical analysis adds value to commonly used allocation rules that invest fixed proportions of wealth in stocks. When there is uncertainty about predictability, the fixed allocation rules combined with technical analysis can outperform the prior-dependent optimal learning rule when the prior is not too informative. Moreover, the technical trading rules are robust to model specification, and they tend to substantially outperform the model-based optimal trading strategies when there is uncertainty about the model governing the stock price.
Number of Pages in PDF File: 54
Keywords: Technical analysis, trading rules, asset allocation, predictability, learning
JEL Classification: G11, G12, G14, C11, C61
Date posted: March 5, 2007
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