Technical Analysis as a Source of Exchange-Rate Forecast Irrationality: The Head-and-Shoulders Pattern

Posted: 7 Jan 1998

See all articles by Carol L. Osler

Carol L. Osler

Brandeis University - International Business School

P. H. Kevin Chang

Credit Suisse AG - London Headquarters

Date Written: August 1995

Abstract

Much empirical research suggests that exchange-rate forecasts are not rational. This paper identifies a commonly used technical trading signal, the head-and-shoulders pattern, as a potential source of that irrationality. We use an objective, computer-implemented algorithm to identify head-and-shoulders patterns in daily dollar exchange rates during the floating rate period. The resulting profits, replicable in real time, are then evaluated statistically using the bootstrap technique. We impose two conditions for trading-rule rationality: a rule must be profitable and it must not be dominated by other trading rules. We find that head-and-shoulders trading generates statistically significant profits, and thus satisfies the first condition. However, the trading rule is dominated by simple filter rules, so it does not satisfy the second condition.

JEL Classification: F31, G12, G14

Suggested Citation

Osler, Carol L. and Chang, P.H. Kevin, Technical Analysis as a Source of Exchange-Rate Forecast Irrationality: The Head-and-Shoulders Pattern (August 1995). Available at SSRN: https://ssrn.com/abstract=51421

Carol L. Osler (Contact Author)

Brandeis University - International Business School ( email )

Mailstop 32
Waltham, MA 02454-9110
United States
781-736-4826 (Phone)

P.H. Kevin Chang

Credit Suisse AG - London Headquarters ( email )

One Cabot Square
London E14 4QJ
United Kingdom
+44 171 888 8535 (Phone)
+44 171 888 4775 (Fax)

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