Skewness Preference and the Popularity of Technical Analysis

73 Pages Posted: 16 Nov 2013 Last revised: 8 Dec 2019

See all articles by Sebastian Ebert

Sebastian Ebert

Heidelberg University

Christian Hilpert

Sun Yat-sen University (SYSU) - Lingnan (University) College

Date Written: February 24, 2016

Abstract

The popularity of technical analysis is puzzling. We propose a simple model of how investors evaluate a trading rule, and show that the market timing of technical trading rules induces lottery-like trading profits. Therefore, investors' preference for positive skewness caters to the popularity of technical analysis. Since prospect theory implies strong skewness preference, it can explain why investors trade extensively on chart patterns that are meaningless in light of the efficient market hypothesis. Advocates of technical analysis often invoke behavioral finance as its theoretical foundation. Contrary to this view, our paper shows that ideas from behavioral finance can explain why technical analysis is popular despite its lack of theoretical foundation and empirical success.

Keywords: Behavioral Finance, Market Timing, Moving Average, Prospect Theory, Skewness Preference, Technical Analysis

JEL Classification: G02, G11, D03, D14

Suggested Citation

Ebert, Sebastian and Hilpert, Christian, Skewness Preference and the Popularity of Technical Analysis (February 24, 2016). Available at SSRN: https://ssrn.com/abstract=2354962 or http://dx.doi.org/10.2139/ssrn.2354962

Sebastian Ebert

Heidelberg University ( email )

Grabengasse 1
Heidelberg, 69117
Germany
06221543443 (Phone)
69115 (Fax)

Christian Hilpert (Contact Author)

Sun Yat-sen University (SYSU) - Lingnan (University) College ( email )

GuangZhou, GuangDong
China

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