Sentiment and the Effectiveness of Technical Analysis: Evidence from the Hedge Fund Industry

Abstract

This paper presents a unique test of the effectiveness of technical analysis in different sentiment environments by focusing on its usage by perhaps the most sophisticated and astute investors, namely hedge fund managers. We document that during high-sentiment periods, hedge funds using technical analysis exhibit higher performance, lower risk, and superior market-timing ability than non-users. The advantages of using technical analysis disappear or even reverse in low-sentiment periods. Our findings are consistent with the view that technical analysis is relatively more useful in high-sentiment periods with larger mispricing, which cannot be fully exploited by arbitrage activities due to short-sale impediments.

Keywords: Investor sentiment, technical analysis, hedge funds, fund performance, risk, timing ability

JEL Classification: G12, G14, G23