Conclusions from the literature
Technical analysis is heavily used in practice to make forecasts about speculative price series. However, early statistical studies found that successive price changes are linearly independent, as measured by autocorrelation, and that financial price series may be well defined by random walks. In that case technical trading should not provide valuable trading signals. However, it was argued that the dependence in price changes might be of such a complicated nonlinear form that standard linear statistical tools might provide misleading measures of the degree of dependence in the data. Therefore several papers appeared in the academic literature testing the profitability of technical analysis. The general consensus in academic research on technical analysis is that there is some but not much dependence in speculative prices that can be exploited by nonlinear technical trading rules. Moreover, any found profitability seems to disappear after correcting for transaction costs and risk. Only floor traders who face very small transaction costs can possibly reap profits from technical trading. Most papers consider a small set of technical trading rules that are said to be widely known and frequently used in practice. This causes the danger of data snooping. However, after correction for the specification search, it is still found that those technical trading rules show forecasting power in the presence of small transaction costs. It is noted by many authors that the forecasting power of technical trading rules seems to disappear in the stock markets as well as in the currency markets during the 1990s, if there was any predictive power before. It is argued that this is likely to be caused by computerized trading programs that take advantage of any kind of patterns discovered before the mid 1990s causing any profit opportunity to disappear.
1.3 Outline of the thesis
The efficient markets hypothesis states that in highly competitive and developed markets it is impossible to derive a trading strategy that can generate persistent excess profits after correction for risk and transaction costs. Andrew Lo, in the introduction of Paul Cootner's ``The Random Character of Stock Prices'' (2000 reprint, p.xi), suggests even to extend the definition of efficient markets so that profits accrue only to those who acquire and maintain a competitive advantage. Then, those profits may simply be the fair reward for unusual skill, extraordinary effort or breakthroughs in financial technology. The goal of this thesis is to test the weak form of the efficient markets hypothesis by applying a broad range of technical trading strategies to a large number of different data sets. In particular we focus on the question whether, after correcting for transaction costs, risk and27