Two Technical Analysis Rules Pass Academic Muster

Technical analysis has long been looked down upon in many influential circles. Academicians publish countless articles “proving” that technical analysis lacks merit. Technical analysis has also not been highly thought of by modern Wall Street analysts trained at the leading business schools, and skeptical journalists have not exactly been favorable to technical analysis, either.

The concept behind technical analysis is that the study of the market itself can lead the investor to form expectations regarding the future course of prices. By studying past prices, an accurate appraisal of the demand/supply equation for stocks can be achieved and forecasts can be made regarding their future course.

“Baloney,” say the efficient market theorists. A stock price at any point in time effectively discounts all pertinent information and any future price action will tend to be random or will reflect new information, rather than any pattern suggested by technical analysis.

So, it came as more than just a mild surprise when an article in the December issue of The Journal of Finance, “Simple Technical Trading Rules and the Stochastic Properties of Stock Returns,” reported some study results favorable to technical analysis.

The objective of the authors, William Brock and Blake LeBaron, both from the University of Wisconsin, and Josef Lakonishok of the University of Illinois, was to test two basic indicators in technical analysis—moving averages and trading-range break—as to whether these indicators were able to forecast future price changes.

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