Technical Analysis in the Foreign Exchange Market

Federal Reserve Bank of St. Louis Working Paper No. 2011-001B

41 Pages Posted: 5 Jan 2011 Last revised: 26 Jul 2011

Christopher J. Neely

Federal Reserve Bank of St. Louis - Research Division

Paul A. Weller

University of Iowa - Department of Finance

Date Written: July 24, 2011

Abstract

This article introduces the subject of technical analysis in the foreign exchange market, with emphasis on its importance for questions of market efficiency. “Technicians” view their craft, the study of price patterns, as exploiting traders’ psychological regularities. The literature on technical analysis has established that simple technical trading rules on dollar exchange rates provided 15 years of positive, risk-adjusted returns during the 1970s and 80s before those returns were extinguished. More recently, more complex and less studied rules have produced more modest returns for a similar length of time. Conventional explanations that rely on risk adjustment and/or central bank intervention do not plausibly justify the observed excess returns from following simple technical trading rules. Psychological biases, however, could contribute to the profitability of these rules. We view the observed pattern of excess returns to technical trading rules as being consistent with an adaptive markets view of the world.

Keywords: Exchange Rate, Technical Analysis, Technical Trading, Intervention, Efficient Markets Hypothesis, Adaptive Markets Hypothesis

JEL Classification: F31, G14, G11, G15

Suggested Citation

Neely, Christopher J. and Weller, Paul A., Technical Analysis in the Foreign Exchange Market (July 24, 2011). Federal Reserve Bank of St. Louis Working Paper No. 2011-001B. Available at SSRN: https://ssrn.com/abstract=1734836 or http://dx.doi.org/10.2139/ssrn.1734836

Christopher J. Neely (Contact Author)

Federal Reserve Bank of St. Louis - Research Division ( email )

411 Locust St
Saint Louis, MO 63011
United States
314-444-8568 (Phone)
314-444-8731 (Fax)

HOME PAGE: http://www.stls.frb.org/research/econ/cneely/

Paul A. Weller

University of Iowa - Department of Finance ( email )

Iowa City, IA 52242-1000
United States
319-335-1017 (Phone)
319-335-3690 (Fax)

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