Blog - Investing Notes

September 18, 2006 - Does Technical Trading Work for Certain Kinds of Stocks?

Can technical traders make money if they focus on stocks that are small, illiquid or in specific industries? In their September 2006 paper entitled "Is Technical Analysis Profitable on U.S. Stocks with Certain Size, Liquidity or Industry Characteristics?", Ben Marshall, Sun Qian and Martin Young test three widely used technical trading rules: (1) the variable length moving average rule: (2) the fixed length moving average rule; and, (3) the trading range break-out rule. Using daily close data for 1,065 NYSE and NASDAQ stocks trading over the entire period 1990-2004, they find that:

• Across the entire sample, technical trading is generally not profitable. On average, the trading rules yield significant profits for only 3% of stocks. This result is consistent for different intervals and for both NYSE and NASDAQ stocks.
• There is some evidence that technical trading is more profitable for small-capitalization and low-volume stocks than for large-capitalization and high-volume stocks.
• For a small minority of stocks, profits from technical analysis are very large compared to transaction costs. These big winners may encourage traders to continue using the rules.
• There is no apparent relationship between a stock’s industry and the level of profitability of technical analysis.

In summary, technical trading is more likely to be successful when applied to small-capitalization and illiquid stocks.

It may be that successful technical traders have ways to find stocks for which technical analysis is most applicable.

For related research, see Blog Synthesis: Some Trading Indicators. See especially our blog entry of 4/11/05, offering a broader test of technical indicators and generally similar conclusions.