The Predictive Power of Head-and-Shoulders Price Patterns in the U.S. Stock Market
Posted: 16 Jun 2008
Date Written: Spring 2007
We use the pattern recognition algorithm of Lo, Mamaysky, and Wang () with some modifications to determine whether head-and-shoulders (HS) price patterns have predictive power for future stock returns. The modifications include the use of filters based on typical price patterns identified by a technical analyst. With data from the S&P 500 and the Russell 2000 over the period 1990 1999 we find little or no support for the profitability of a stand-alone trading strategy. But we do find strong evidence that the pattern had power to predict excess returns. Risk-adjusted excess returns to a trading strategy conditioned on head-and-shoulders price patterns are 5 7% per year. Combining the strategy with the market portfolio produces a significant increase in excess return for a fixed level of risk exposure.
Keywords: kernel regression, stock prices, technical analysis
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