Academic journal article International Journal of Management

The Use of Technical Trading Rules to Predict Overall Stock Price Movements: A Study on Share Prices on the Irish Stock Exchange

Academic journal article International Journal of Management

The Use of Technical Trading Rules to Predict Overall Stock Price Movements: A Study on Share Prices on the Irish Stock Exchange

Article excerpt

Technical analysis is a challenge to buy-and-hold method of investing. Well-defined trading rules are developed based on statistics generated by market activities such as volume, open interest and past price movements. The key tenet of a trading rule is that strict signals are given for market entry and exit points, based on well-defined criteria of each rule. In this article we investigate six popular technical trading rules using data from the Irish Stock Market from March 15th 1988 to October 15th of 2010. If technical analysis cannot predict price movements, then we should observe that the buy days returns do not differ appreciably from sell days returns; the results of Table 2 and 3 show that all buy-sell differences are positive and the t-stats for these differences are highly significant, rejecting the null hypothesis of equality of buy days returns with sell days returns. Whether an investor can exploit this predictive power of trading rules and design profitable strategies to achieve greater returns than the buy and hold strategy depends to transaction costs. If one-way Irish equity transaction cost is close to 50 basis points, then technical trading can generate greater returns than the buy and hold strategy.

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Introduction

Technical Analysis has significantly evolved from the graphical approach in the early days to a more sophisticated computational approach used in the present day. We can define technical analysis as a method of evaluating commodities and stock prices by analyzing statistics generated by market activity, such as volume, open interest, past prices, and various indicators calculated from prices and volume. In this article we will apply six of the most well known technical analysis indicators to the Irish Stock Market. Earlier studies up to mid-80s supported the weak-form efficient market hypothesis and supported the futility of using technical analysis in stock market investing. However, since the mid 1980s, technical trading has been enjoying more favorable view in academic circles. The cornerstones of this new research were three articles by Sweeney (1986), Lukac et al. (1988), and Brock et al. (1992). Since the publication of the above three articles there have been a myriad of research on technical trading rules; most studies supported the usefulness of technical analysis, however when including transaction costs, the evidence of profitable trading is mixed, many studies show that the profit vanishes when considering transaction costs. Park and Irwin (2007) and Menkhoff and Taylor (2007) provide excellent surveys of technical trading literatures up to 2004.

We will now cite some additional research on technical trading literature after 2004. Marshall and Cahan (2005) apply 12 popular technical indicators to the New Zealand stock market and conclude that technical analysis does not work in the New Zealand stock market. Chang et al. (2006) apply various moving average trading rules to the Taiwan stock market and conclude that it is possible to use technical analysis to beat the buy and hold (B&H) strategy. Loh (2007) combining moving average and stochastic oscillator with trend indicators conclude that the addition of these two technical indicators dramatically improve the power of forecasting in five Asian-Pacific stock markets. Bajgrowicz and Scaillet (2008) revisit the apparent success of technical trading rules of daily prices of the Dow Jones index. They conclude that even if we can find some technical trading rules that perform well historically, it is not possible to identify them ex ante; in addition they conclude that once transaction costs are included, the superior performance of these rules will be wiped out. Metghalchi et al. (2008) apply various moving average trading rules for the Swedish stock market and they conclude that technical trading can beat the buy and hold strategy even accounting for data snooping and transaction costs. …

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