A Theory of Technical Trading Using Moving Averages
45 Pages Posted: 17 Sep 2013 Last revised: 23 Mar 2014
Date Written: March 22, 2014
In practice, traders, such as high-frequency and day traders, rely in part or primarily on moving averages to predict market directions, but their equilibrium impact is unknown. This paper presents a model to analyze how such technical traders compete trading with informed investors and how they affect the market risk premium. Our model can explain both the time series momentum, documented by Moskowitz, Ooi and Pedersen (2012), that market prices tend to be positively correlated in the short-run and negatively correlated in the long-run, and the trend factor, proposed by Han and Zhou (2013), that high abnormal returns can be earned on a portfolio using moving averages to capture trends of various time horizons.
Keywords: Technical analysis, trend-following, asymmetric information
JEL Classification: G11, G12, G14, C11, C61
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