Academic journal article International Management Review

Toward a Prediction Model of Position Outcome for Technical Trading

Academic journal article International Management Review

Toward a Prediction Model of Position Outcome for Technical Trading

Article excerpt

(ProQuest: ... denotes formulae omitted.)


Technical Analysis is the systematic evaluation of past market data to estimate future price trends and make investment decisions (Kaufman, 2013, p.1). To trade technically is to predefine the conditions for both the entrance and exit of a market position. With predefined conditions that denote the beginning and end of a market position, it is argued that the historic pricing of a security traded with a technical system can be viewed as a collection of historic market positions. Associated with each market position is a set of market conditions that reflect the change in equilibrium of a security's price. It is suggested these market conditions can be quantified with the use of technical indicators and potentially used as predictors of market position outcome.

Speculative Investors react to market news and take positions in anticipation the security price will rise (or fall if short) in the near future. A short term investor will evaluate changes in the security's price in an effort to identify the change in the market equilibrium and the corresponding trend. The common objective of a speculator is to accurately anticipate the next move of the market. This can be accomplished by (1) recognizing recurring patterns in price movement and determining the most likely results of such patterns, and (2) identifying the "trend" of the market by isolating the basic direction of prices over a selected time interval (Kaufman, 2013, p.5). A unique aspect of this research is modeling a dynamic market "event" defined by a technical trading system opposed to forecasting future security pricing over some predetermined horizon (i.e. 1 day, 5days, etc.). It is argued that a target investment horizon of less than a quarter of a fiscal year focuses more on the market behavior of a security rather than traditional fundamental analysis. Modelling market events is more reflective of behavioral or how the market reacts to conditions. Using four randomly selected securities, this research paper investigates the relationship of three momentum based technical indicators to the outcome of market positions defined by a 21-day Simple Moving Average (SMA) trading system. The purpose of this research is to determine if technical momentum indicators vary with the classification of position outcome. The ultimate objective is to determine if the selected technical momentum indicators can be used as features in a prediction model to help form an expectation about position outcome at the time an entry signal is given.

Literature Review

Market Efficiency

The price of a security is determined by the market participants (buyers and sellers) of an open market. The theoretical equilibrium price of a stock is where the return on investment (appreciation of share value plus dividends) balances with the risk of the investment relative to the returns of a risk-free alternative (Kaufman, 2013, p.7). When the supply and demand dynamics of a security change the price must also change to bring the market back into equilibrium. More specifically, if the supply exceeds the demand, the security price should fall and if the demand exceeds the supply, the security price should rise (Tsai & Hsiao, 2010). Security prices will seek a level that balances the supply and demand factors. The equilibrium price point is reached either instantaneously or in an unpredictable manner as prices move in response to the latest available information or news release (Kaufman, 2013, p.6).

Market efficiency refers to the speed that information is reflected in security pricing (Gold, 1999). In a perfectly efficient market, new information concerning a security should be reflected instantaneously. However, if only some of the information is reflected in the security pricing instantaneously, and the remaining information takes a number of periods to be reflected (hours/days/weeks), then the market is less than fully efficient leading to short term mispricing and an opportunity to generate excess profit (CFA Institute, 2008). …

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