information useful for technical analysis, because analysts cannot differentiate between price series with information content and price series with no information content.

Technical analysis in the foreign currency markets

One of the earliest studies of the profitability of technical trading rules in foreign exchange markets is Dooley and Shafer (1983). Very high liquidity, low bid-ask spreads and round-the-clock decentralized trading characterize exchange rate markets for foreign currency. Furthermore, because of their size, these markets are relatively immune to insider trading. Dooley and Shafer (1983) address the question whether the observed short-run variability in exchange rates since the start of generalized floating exchange rates in March 1973 is caused by technical traders or is caused by severe fundamental shocks. In the former case the exchange rate path could be interpreted in terms of price runs, bandwagons, and technical corrections, while in the latter case frequent revisions on the basis of small information occurs and the market is efficient in taking into account whatever information is available. They follow the study of Fama (1965, 1970) by applying serial correlation tests, runs tests and seven filter trading rules in the range [1%, 25%] to the US Dollar (USD) prices of the Belgium Franc (BF), Canadian Dollar (CD), French Franc (FF), German Mark (DEM), Italian Lira (IL), Japanese Yen (JPY), Dutch Guilder (DGL), Swiss Franc (SF), and the British Pound (BP) in the period March 1973 through November 1981. Adjustment is made for overnight Eurocurrency interest rate differentials to account for the predictable component of changes in daily spot exchange rates. In an earlier study Dooley and Shafer (1976) already found that the filters yielded substantial profits from March 1975 until October 1975 even if careful account was taken of opportunity costs in terms of interest rate differentials and transactions costs. It is noted that these good results could be the result of chance and therefore the period October 1975 through November 1981 is considered to serve as an out-of-sample testing period for which it is unlikely that the good results for the filters continue to hold if the exchange markets are really efficient. Dooley and Shafer (1983) report that there is significant autocorrelation present in the data and that there is evidence of substantial profits to all but the largest filters, casting doubt on the weak form of the efficient markets hypothesis. Further, they find a relation between the variability of exchange rates, as measured by the standard deviation of the daily returns, and the filter rules' profits. A large increase in the variability is associated with a dramatic increase in the profitability of the filters. They also compare the results generated in the actual exchange rate data with results generated by random walk and autoregressive models, which in the end cannot explain the findings.
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