Price Trends and Patterns in Technical Analysis: A Theoretical and Empirical Examination

47 Pages Posted: 20 Mar 2007  

Paul A. Weller

University of Iowa - Department of Finance

Geoffrey C. Friesen

University of Nebraska at Lincoln - Department of Finance

Lee M. Dunham

Creighton University - College of Business Administration

Date Written: August 2007

Abstract

We develop a formal model of asset prices in which investors are subject to confirmation bias, which describes the tendency of individuals to search for and interpret information selectively to conform to a given set of beliefs. The model produces three notable results. First, the model generates price patterns which validate certain well-documented trading strategies, in particular the "head-and-shoulders" pattern. Second, asset prices exhibit negative autocorrelations over very short horizons, positive autocorrelations over intermediate horizons, and negative autocorrelations over long horizons, which matches the observed stylized properties of U.S. equity prices. Third, the model predicts that sequential price jumps for a particular stock will be positively autocorrelated. Several recent econometric papers have shown that one can identify significant jumps by comparing realized volatility and bi-power return variation. Using this methodology, together with tick-by-tick data on all stocks in the S&P 100 index from 1999-2005, we identify and calculate significant jumps in stock prices. Consistent with the predictions of the model, we find that jumps exhibit statistically and economically significant positive autocorrelations.

Keywords: Technical Analysis, Trading Rules, Equity Jumps, Momentum, Confirmatory Bias

JEL Classification: G14, G11, G1

Suggested Citation

Weller, Paul A. and Friesen, Geoffrey C. and Dunham, Lee M., Price Trends and Patterns in Technical Analysis: A Theoretical and Empirical Examination (August 2007). Available at SSRN: https://ssrn.com/abstract=970852 or http://dx.doi.org/10.2139/ssrn.970852

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)

Geoffrey C. Friesen (Contact Author)

University of Nebraska at Lincoln - Department of Finance ( email )

Department of Finance
Lincoln, NE 68588-0489
United States
402-472-2334 (Phone)

Lee M. Dunham

Creighton University - College of Business Administration ( email )

United States
(402) 280-2637 (Phone)

HOME PAGE: http://https://business.creighton.edu/faculty-directory-profile/433/lee-dunham

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