Effectiveness of technical trading rules

Abstract

Stock market analysts have developed a number of trading rules that help traders decide their future strategy with respect to a particular stock or portfolio of stocks. Technical forecasting relies on past data to make a prediction. Technical analysis, therefore, fundamentally challenges the Efficient Market hypothesis (EMH) on two fronts: 1. It contends that past prices and volumes can be indicators of future trends. 2. It assumes gradual adjustment of price to reflect the gradual flow of information. There are other challenges to trading rules as well. These rules are conditional and may not give the result every time. Similarly, for a given condition, not all trading rules give the same result. Even analysts use a number of trading rules while looking at a particular stock/portfolio before making a decision. However, some trading rules like price movement and volume analysis have been all time favorites. How effective these rules have been, Is still a matter of debate? Not all trading rules can be applied in all conditions. Similarly, some rules may have performed better than other rules. Apart from this, there may be some combinations of rules that could have been more useful. In spite of these challenges to technical trading rules, we observed that traders frequently use these rules. The reason is simple. Technical analysts believe that fundamental analysts can experience superior returns only of they obtain new information before other investors and process it correctly and quickly. To boot technical analysis is not reliant on financial accounting statements – the major source of information about the past performance of a firm or industry. In our project, we have attempted to compare the effectiveness of technical analysis vis-à-vis native trading strategies like buy and hold.