What Is the Empirical Support for Technical Analysis?

Despite the theoretical criticisms, can technical analysts use past price data to predict future price movement? Over the years, hundreds of studies have been conducted to test the efficacy of technical trading rules. Cheol-Ho Park and Scott Irwin conducted one of the most extensive reviews of these tests. In their 2003 report, they review 92 post-1986 academic studies that tested the profitability of technical analysis strategies.²

Many tests of technical trading strategies conducted before the mid-1980s focused on only one or two trading systems, did not test for statistical significance of trading profits, and did not correctly address issues of risk.

Of the 92 studies reviewed, 58 of the studies concluded that positive results could be gained from using technical analysis; only 24 of the studies concluded that the use of technical strategies led to negative results. Under the Random Walk Hypothesis, because prices returns are independent of each other, no technical trading strategy should be consistently profitable. Believers in the Random Walk Hypothesis do admit that a strategy could appear to be profitable ex-post, but that this profitability was simply due to luck, not a successful technical trading rule. However, the fact that two-thirds of the studies that Park and Irwin reviewed showed positive results could not be attributed to luck. Of course, as Park and Irwin point out, criticism can be made of some of the reviewed studies in that the various testing methods used by the researchers were in some cases subject to data snooping and ex-post selection of trading rules; some of these studies may also be flawed due to difficulties in estimating risk and transaction costs. It is unlikely, however, that all 58 positive studies are at fault for testing deficiencies. Park and Irwin’s summary results at least show possible refutation of the Random Walk and the Efficient Markets Hypotheses, something that until recently had not been accomplished with rigorous testing of trading rules.

Source: Kirkpatrick II Charles D., Dahlquist Julie R. (2015), Technical Analysis: The Complete Resource for Financial Market Technicians, FT Press; 3rd edition.