Blog - Investing Notes

Blog Synthesis: Some Trading Indicators

Does technical trading work, or not? Rationalists dismiss it; behavioralists investigate it. Is there any verdict yet? Here is a listing of past blog entries related to technical trading:

Trading After N-day Highs and Lows ...round-number n-day highs and lows on average trigger elevated trading volume and return reversals. The average reversal after lows (highs) is relatively large (small) and may be tradable (is probably not tradable).

Technical Analysis Tested on Long-run DJIA Data ...this evidence does not support a belief that technical trading rules reliably generate out-of-sample outperformance after accounting for trading frictions.

Combining RSI and MACD in Search of Concentrated Abnormal Returns ...evidence from simple tests indicates that combining RSI and MACD signals probably does not enhance, but instead may degrade, returns from trading a broad market index.

A Simple Test of MACD Crossover as an Abnormal Returns Indicator ...a broad index trading strategy based solely on MACD crossovers probably has difficulty keeping up with buy-and-hold over long periods, but MACD crossover signals might be useful within more complex strategies.

A Simple Test of RSI as an Abnormal Returns Indicator ...a broad index trading strategy based solely on RSI oversold/overbought signals probably underperforms buy-and-hold over long periods, but RSI signals might be useful within more complex strategies.

Does a Long-Term Moving Average Indicator Predict Big Days? ...an investor who enters (exits) the market when the S&P 500 index crosses above (below) its 200-day moving average may miss most of the extremely high volatility days but will probably not enhance cumulative return by missing them.

A Tradable Accruals Anomaly ...firm accruals may be a good indicator of future stock returns when combined with a broader measure of firm financial health, or when defined as a fraction of earnings rather than assets.

99 Cents Is Not a Sale Price ...short-term returns are on average significantly higher (lower) following closing prices that lie just above (below) a round number. The effect is probably of ancillary use only to traders.

The Cramer Size Effect? ...Jim Cramer's buy (sell) recommendations tend to gap up (down) overnight to a degree inverse to market capitalization and then level off or reverse over the next few weeks. In general, investors cannot capture the gaps. The best play for traders is to buy Cramer-initiated small-cap sell recommendations within a few days and wait for reversal over the next few weeks.

Are Homebuilder Stocks Early Warning Indicators for Equities in General? ...evidence from a simple analysis of historical stock prices does not support a belief that homebuilder stocks are early warning indicators for equities in general.

Reader Question on the "Double 9-to-1 Up Day" Signal ...double 9-to-1 up day events may reliably signal abnormal short-term returns, but designing a system to exploit such rare and unpredictable signals is problematic.

Does the Bullish Percent Index Predict Market Direction? ...weaknesses in the methodology of this study substantially undercut its conclusion that the average Bullish Percent across sectors is very useful for predicting stock returns.

Are Strong or Weak Daily Closes Predictive? ...relatively weak and strong daily closes say nothing about next-day returns. Weak closes over the past several days are very slightly (untradably) predictive of above-average returns over the next few days.

Exploiting Global Plunge Contagion? ...Asian stock markets do to some degree follow the U.S. market, including its sharp drops. However, U.S. market plunges are rare and clustered, the Asian market responses to these plunges are noisy, and untradable overnight/weekend gaps down on Asian markets substantially limit exploitation of any "plunge contagion."

Does Technical Trading Work with Commodity Futures? ...market timing based on technical analysis is not reliably profitable for commodity futures.<

Are Moving Average Crossovers/Crossunders Good Buy/Sell Signals? ...moving average crossunders/crossovers may have some practical value as buy/sell signals for long averaging intervals, generating comparable returns with lower volatility. However, the tax consequences of trading could more than offset that value.

Bollinger Bands: Buy Low and Sell High? ...Bollinger Bands for the aggregate stock market do provide some sense of overbought/oversold (and future volatilty), but they do not as standalone indicators support a trading strategy that beats buy-and-hold.

Testing Engulfing Candlesticks ...bullish and bearish engulfing candlesticks for the S&P 500 index have no practical value for trading.

Are Bad Weeks (Months) Followed by Good Ones? ...the stock market after a bad week (month) exhibits neither momentum nor reversal reliably the following week (month).

Testing the QQQQ Crash Trade Trigger ...the QQQQ Crash Trade Trigger scheme may work well in bear markets, but not so much in bull markets. Beware of small samples and favorable starting points.

Chumming with Sharks? ...agile traders may be able to capture significant short-term gains in stocks targeted by hedge funds via large equity positions and aggressive, specific and public demands on management.

Does Customer Satisfaction Translate to Excess Stock Returns? ...stocks of firms with high ACSI customer satisfaction ratings outperform the market on average over the long term. Said differently, investors appear to undervalue customer satisfaction systematically.

Do Good Employers Make Good Investments? ...the (Fortune magazine) best places to work make on average good long-term investments.

Technical Analysis: "Anathema to the Academic World"? ...there is no evidence of any systematic intraday inefficiencies in SPDR data.

Testing the Head-and-Shoulders Pattern ...head-and-shoulders technical analysis is likely unprofitable as a standalone trading strategy in rising markets, but it may work well in designing hedged portfolios.

Candlesticks? Fiddlesticks! ...neither bullish nor bearish candlestick signals reliably generate abnormal returns in the expected direction for large-capitalization U.S. stocks during recent years.

Conservatism Bias in Earnings Forecasts ...investors systematically overvalue (undervalue) stocks when they expect earnings per share to be low (high). Their expectations exhibit conservatism bias with respect to both the downside and upside extremes.

Does Aggregate Technological Innovation Predict Stock Returns? ...stock market returns positively but weakly predict changes in the level of future innovation, but changes in the level of innovation do not predict stock returns.

Pining for a Correction? ...even though aggregate stock prices have trended up since the beginning of 2004, stock market value and real return are arguably the same or higher now than then. The trend and the need for correction depend on perspective: psychology, value or real earnings yield.

POMO, TOMO and Stock Returns ...analysis of available data does not support the hypothesis that the Federal Reserve attempts to manipulate the stock market via its Open Market Operations.

Review of the Financial Forecast Center's Forecasts ...while the nine-month sample assembled does not support statistically reliable conclusions, the Financial Forecast Center's approaches to forecasting the S&P 500 index and the CPI do not look promising.

Follow-up on Streak Reversals: Some Nasdaq Disorderly Conduct ...in contrast with the S&P 500 index, the Nasdaq Composite index does not support a finding of systematic streak reversal behavior during 2004-2006.

Out-of-Sample Test of Trading Streak Reversals ...while the average daily returns immediately after up (down) stock market streaks may be systematically lower (higher) than average, traders relying on index streak reversals will likely underperform a buy-and-hold investor most of the time.

Bet Against Big Sympathy Moves? ...investors appear to overreact systematically in projecting a firm's earnings results to the near-term earnings announcements of peer companies.

Evidence-Based Technical Analysis: Applying the Scientific Method and Statistical Inference to Trading Signals (Chapter-by-Chapter Review) Taken in parts, this book offers sound methods for analysis. Taken as an integrating whole, it offers insightful context for evaluating a broad range of financial analyses/claims presented by others. Here is a chapter-by-chapter review of some of the insights in this book...

Reader Question on the "Tired" Bull Market ...we know of no way to forecast either the size or duration of stock market trends (or trend reversals) that is reliable enough for successful market timing. Fundamentals (production, consumption, earnings, dividends, interest rates) matter, but lack of compelling theory keeps the forecasters chasing data.

Returns from Pattern-Based Technical Analysis? ...even if pattern-based technical analysis can yield abnormal returns (with transaction costs), success may be critically sensitive to precise pattern definitions and pattern recognition capability.

Trade Against Overnight Moves? ...the overnight return on individual stocks is a contrary indicator for next-day returns, but individual "outside" traders may not be able to exploit this tendency.

Technical Analysis as Folk Medicine ...the incorporation of folk medicine by pharmacology offers a model for bringing technical analysis into the financial economics fold.

Does Technical Trading Work for Certain Kinds of Stocks? ...technical trading is more likely to be successful when applied to small-capitalization and illiquid stocks.

Reader Questions on Stock Price Impacts of Management Changes ...there may be a good short-term price trade (but watch out for frontrunning) and a good longer-term volatility play for forced resignation of a CEO with replacement by an outsider.

It's a Mad, Mad, Mad, Mad Market? ...the losers are the Mad Money viewers who buy recommended stocks at the open the next day. The winners are the market makers and arbitrageurs who sell the overpriced recommendations on day 1, and the traders who sell them on days 2 through 12.

Testing the Indicators of Barchart.com: Barchart.com generally leans a little the wrong way with respect to near term aggregate stock market action. This tendency is probably too weak to be tradable. Its indicators appear to overweight (underweight) the trend-following (reversal) nature of the market.

A Reader's Out-of-sample Test of Some Technical Trading Research ...investors/traders must assume substantial doubt regarding the assertions even of academic experts regarding financial markets.

Unexplained Volume as a Critical Indicator ...investors/traders should focus first on unexplained volume in a stock, and then on its bid-ask spread, as indicators of future abnormal returns.

Pricing Market News ...the stock market shows significant predictability (rather than perfect efficiency) in its reactions to news.

Technical Trading Thoroughly Tested ...technical analysis can be significantly profitable when applied to relatively immature stock indices (NASDAQ Composite and Russell 2000) but not when applied to mature stock indices (DJIA and S&P 500).

Technically, It Pays to Think Small ...a trading strategy based on simple moving averages is most appropriate for small capitalization stocks.

Information-Based Trading ...the higher the probability that trading in a stock is informed, the greater the size and persistence of stock price movement.

Identifying Market Breakouts The key to anticipating market breakouts – rather than getting on board once they’ve begun – is finding the leaders…

In summary, there is evidence that some technically-oriented trading rules have economic value for stock traders, especially in trading small-capitalization stocks.