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Foundations of Technical Analysis:Computational Algorithms, Statistical
Inference, and Empirical Implementation
ANDREW W. LO, HARRY MAMAYSKY, AND JIANG WANG*
ABSTRACT
Technical analysis, also known as charting, has been a part of financial practicefor many decades, but this discipline has not received the same level of academicscrutiny and acceptance as more traditional approaches such as fundamental analy-sis. One of the main obstacles is the highly subjective nature of technical analy-sisthe presence of geometric shapes in historical price charts is often in the eyesof the beholder. In this paper, we propose a systematic and automatic approach totechnical pattern recognition using nonparametric kernel regression, and we applythis method to a large number of U.S. stocks from 1962 to 1996 to evaluate theeffectiveness of technical analysis. By comparing the unconditional empirical dis-tribution of daily stock returns to the conditional distributionconditioned on spe-cific technical indicators such as head-and-shoulders or double-bottomswe findthat over the 31-year sample period, several technical indicators do provide incre-mental information and may have some practical value.
ONE OF THE GREATEST GULFS between academic finance and industry practiceis the separation that exists between technical analysts and their academiccritics. In contrast to fundamental analysis, which was quick to be adoptedby the scholars of modern quantitative finance, technical analysis has beenan orphan from the very start. It has been argued that the difference be-tween fundamental analysis and technical analysis is not unlike the differ-ence between astronomy and astrology. Among some circles, technical analysisis known as voodoo finance. And in his inf luential book A Random Walkdown Wall Street, Burton Malkiel ~1996! concludes that @u#nder scientificscrutiny, chart-reading must share a pedestal with alchemy.
However, several academic studies suggest that despite its jargon and meth-ods, technical analysis may well be an effective means for extracting usefulinformation from market prices. For example, in rejecting the Random Walk
* MIT Sloan School of Management and Yale School of Management. Corresponding author:Andrew W. Lo [email protected]!. This research was partially supported by the MIT Laboratory forFinancial Engineering, Merrill Lynch, and the National Science Foundation ~Grant SBR9709976!. We thank Ralph Acampora, Franklin Allen, Susan Berger, Mike Epstein, Narasim-han Jegadeesh, Ed Kao, Doug Sanzone, Jeff Simonoff, Tom Stoker, and seminar participants atthe Federal Reserve Bank of New York, NYU, and conference participants at the Columbia-JAFEE conference, the 1999 Joint Statistical Meetings, RISK 99, the 1999 Annual Meeting ofthe Society for Computational Economics, and the 2000 Annual Meeting of the American Fi-nance Association for valuable comments and discussion.
THE JOURNAL OF FINANCE VOL. LV, NO. 4 AUGUST 2000
1705
Hypothesis for weekly U.S. stock indexes, Lo and MacKinlay ~1988, 1999!have shown that past prices may be used to forecast future returns to somedegree, a fact that all technical analysts take for granted. Studies by Tabelland Tabell ~1964!, Treynor and Ferguson ~1985!, Brown and Jennings ~1989!,Jegadeesh and Titman ~1993!, Blume, Easley, and OHara ~1994!, Chan,Jegadeesh, and Lakonishok ~1996!, Lo and MacKinlay ~1997!, Grundy andMartin ~1998!, and Rouwenhorst ~1998! have also provided indirect supportfor technical analysis, and more direct support has been given by Pruitt andWhite ~1988!, Neftci ~1991!, Brock, Lakonishok, and LeBaron ~1992!, Neely,Weller, and Dittmar ~1997!, Neely and Weller ~1998!, Chang and Osler ~1994!,Osler and Chang ~1995!, and Allen and Karjalainen ~1999!.
One explanation for this state of controversy and confusion is the uniqueand sometimes impenetrable jargon used by technical analysts, some of whichhas developed into a standard lexicon that can be translated. But there aremany homegrown variations, each with its own patois, which can oftenfrustrate the uninitiated. Campbell, Lo, and MacKinlay ~1997, 4344! pro-vide a striking example of the linguistic barriers between technical analystsand academic finance by contrasting this statement:
The presence of clearly identified support and resistance levels, coupledwith a one-third retracement parameter when prices lie between them,suggests the presence of strong buying and selling opportunities in thenear-term.
with this one:
The magnitudes and decay pattern of the first twelve autocorrelationsand the statistical significance of the Box-Pierce Q-statistic suggest thepresence of a high-frequency predictable component in stock returns.
Despite the fact that both statements have the same meaningthat pastprices contain information for predicting future returnsmost readers findone statement plausible and the other puzzling or, worse, offensive.
These linguistic barriers underscore an important difference between tech-nical analysis and quantitative finance: technical analysis is primarily vi-sual, whereas quantitative finance is primarily algebraic and numerical.Therefore, technical analysis employs the tools of geometry and pattern rec-ognition, and quantitative finance employs the tools of mathematical analy-sis and probability and statistics. In the wake of recent breakthroughs infinancial engineering, computer technology, and numerical algorithms, it isno wonder that quantitative finance has overtaken technical analysis inpopularitythe principles of portfolio optimization are far easier to pro-gram into a computer than the basic tenets of technical analysis. Neverthe-less, technical analysis has survived through the years, perhaps because itsvisual mode of analysis is more conducive to human cognition, and becausepattern recognition is one of the few repetitive activities for which comput-ers do not have an absolute advantage ~yet!.
1706 The Journal of Finance
Indeed, it is difficult to dispute the potential value of price0volume chartswhen confronted with the visual evidence. For example, compare the twohypothetical price charts given in Figure 1. Despite the fact that the twoprice series are identical over the first half of the sample, the volume pat-terns differ, and this seems to be informative. In particular, the lower chart,which shows high volume accompanying a positive price trend, suggests thatthere may be more information content in the trend, e.g., broader partici-pation among investors. The fact that the joint distribution of prices andvolume contains important information is hardly controversial among aca-demics. Why, then, is the value of a visual depiction of that joint distributionso hotly contested?
Figure 1. Two hypothetical price/volume charts.
Foundations of Technical Analysis 1707
In this paper, we hope to bridge this gulf between technical analysis andquantitative finance by developing a systematic and scientific approach tothe practice of technical analysis and by employing the now-standard meth-ods of empirical analysis to gauge the efficacy of technical indicators overtime and across securities. In doing so, our goal is not only to develop alingua franca with which disciples of both disciplines can engage in produc-tive dialogue but also to extend the reach of technical analysis by augment-ing its tool kit with some modern techniques in pattern recognition.
The general goal of technical analysis is to identify regularities in the timeseries of prices by extracting nonlinear patterns from noisy data. Implicit inthis goal is the recognition that some price movements are significanttheycontribute to the formation of a specific patternand others are merely ran-dom fluctuations to be ignored. In many cases, the human eye can perform thissignal extraction quickly and accurately, and until recently, computer algo-rithms could not. However, a class of statistical estimators, called smoothingestimators, is ideally suited to this task because they extract nonlinear rela-tions [m~{! by averaging out the noise. Therefore, we propose using these es-timators to mimic and, in some cases, sharpen the skills of a trained technicalanalyst in identifying certain patterns in historical price series.
In Section I, we provide a brief review of smoothing estimators and de-scribe in detail the specific smoothing estimator we use in our analysis:kernel regression. Our algorithm for automating technical analysis is de-scribed in Section II. We apply this algorithm to the daily returns of severalhundred U.S. stocks from 1962 to 1996 and report the results in Section III.To check the accuracy of our statistical inferences, we perform several MonteCarlo simulation experiments and the results are given in Section IV. Weconclude in Section V.
I. Smoothing Estimators and Kernel Regression
The starting point for any study of technical analysis is the recognition thatprices evolve in a nonlinear fashion over time and that the nonlinearities con-tain certain regularities or patterns. To capture such regularities quantita-tively, we begin by asserting that prices $Pt % satisfy the following expression:
Pt 5 m~Xt ! 1 et , t 5 1, . . . ,T, ~1!
where m~Xt ! is an arbitrary fixed but unknown nonlinear function of a statevariable Xt and $et % is white noise.
For the purposes of pattern recognition in which our goal is to construct asmooth function [m~{! to approximate the time series of prices $ pt % , we setthe state variable equal to time, Xt 5 t. However, to keep our notation con-sistent with that of the kernel regression literature, we will continue to useXt in our exposition.
When prices are expressed as equation ~1!, it is apparent that geometricpatterns can emerge from a visual inspection of historical price seriesprices are the sum of the nonlinear pattern m~Xt ! and white noiseand
1708 The Journal of Finance
that such patterns may provide useful information about the unknown func-tion m~{! to be estimated. But just how useful is this information?
To answer this question empirically and systematically, we must first de-velop a method for automating the identification of technical indicators; thatis, we require a pattern-recognition algorithm. Once such an algorithm isdeveloped, it can be applied to a large number of securities over many timeperiods to determine the efficacy of various technical indicators. Moreover,quantitative comparisons of the performance of several indicators can beconducted, and the statistical significance of such performance can be as-sessed through Monte Carlo simulation and bootstrap techniques.1
In Section I.A, we provide a brief review of a general class of pattern-recognitiontechniques known as smoothing estimators, and in Section I.B we describe insome detail a particular method called nonparametric kernel regression on whichour algorithm is based. Kernel regression estimators are calibrated by a band-width parameter, and we discuss how the bandwidth is selected in Section I.C.
A. Smoothing Estimators
One of the most common methods for estimating nonlinear relations suchas equation ~1! is smoothing, in which observational errors are reduced byaveraging the data in sophisticated ways. Kernel regression, orthogonal se-ries expansion, projection pursuit, nearest-neighbor estimators, average de-rivative estimators, splines, and neural networks are all examples of smoothingestimators. In addition to possessing certain statistical optimality proper-ties, smoothing estimators are motivated by their close correspondence tothe way human cognition extracts regularities from noisy data.2 Therefore,they are ideal for our purposes.
To provide some intuition for how averaging can recover nonlinear rela-tions such as the function m~{! in equation ~1!, suppose we wish to estimatem~{! at a particular date t0 when Xt0 5 x0. Now suppose that for this oneobservation, Xt0, we can obtain repeated independent observations of theprice Pt0, say Pt0
1 5 p1, . . . , Pt0n 5 pn ~note that these are n independent real-
izations of the price at the same date t0, clearly an impossibility in practice,but let us continue this thought experiment for a few more steps!. Then anatural estimator of the function m~{! at the point x0 is
[m~x0! 51
n (i51n
pi 51
n (i51n
@m~x0! 1 eti# ~2!
5 m~x0! 11
n (i51n
eti , ~3!
1A similar approach has been proposed by Chang and Osler ~1994! and Osler and Chang~1995! for the case of foreign-currency trading rules based on a head-and-shoulders pattern.They develop an algorithm for automatically detecting geometric patterns in price or exchangedata by looking at properly defined local extrema.
2 See, for example, Beymer and Poggio ~1996!, Poggio and Beymer ~1996!, and Riesenhuberand Poggio ~1997!.
Foundations of Technical Analysis 1709
and by the Law of Large Numbers, the second term in equation ~3! becomesnegligible for large n.
Of course, if $Pt % is a time series, we do not have the luxury of repeatedobservations for a given Xt . However, if we assume that the function m~{! issufficiently smooth, then for time-series observations Xt near the value x0,the corresponding values of Pt should be close to m~x0!. In other words, ifm~{! is sufficiently smooth, then in a small neighborhood around x0, m~x0!will be nearly constant and may be estimated by taking an average of the Ptsthat correspond to those Xts near x0. The closer the Xts are to the value x0,the closer an average of corresponding Pts will be to m~x0!. This argues fora weighted average of the Pts, where the weights decline as the Xts getfarther away from x0. This weighted-average or local averaging procedureof estimating m~x! is the essence of smoothing.
More formally, for any arbitrary x, a smoothing estimator of m~x! may beexpressed as
[m~x! [1
T (t51T
vt ~x!Pt , ~4!
where the weights $vt ~x!% are large for those Pts paired with Xts near x, andsmall for those Pts with Xts far from x. To implement such a procedure, wemust define what we mean by near and far. If we choose too large aneighborhood around x to compute the average, the weighted average will betoo smooth and will not exhibit the genuine nonlinearities of m~{!. If wechoose too small a neighborhood around x, the weighted average will be toovariable, ref lecting noise as well as the variations in m~{!. Therefore, theweights $vt ~x!% must be chosen carefully to balance these two considerations.
B. Kernel Regression
For the kernel regression estimator, the weight function vt ~x! is con-structed from a probability density function K~x!, also called a kernel:3
K~x! $ 0, EK~u!du 5 1. ~5!By rescaling the kernel with respect to a parameter h . 0, we can change itsspread; that is, let
Kh~u! [1
hK~u0h!, EKh~u!du 5 1 ~6!
3 Despite the fact that K~x! is a probability density function, it plays no probabilistic role inthe subsequent analysisit is merely a convenient method for computing a weighted averageand does not imply, for example, that X is distributed according to K~x! ~which would be aparametric assumption!.
1710 The Journal of Finance
and define the weight function to be used in the weighted average ~equation~4!! as
vt, h~x! [ Kh~x 2 Xt !0gh~x!, ~7!
gh~x! [1
T (t51T
Kh~x 2 Xt !. ~8!
If h is very small, the averaging will be done with respect to a rather smallneighborhood around each of the Xts. If h is very large, the averaging will beover larger neighborhoods of the Xts. Therefore, controlling the degree ofaveraging amounts to adjusting the smoothing parameter h, also known asthe bandwidth. Choosing the appropriate bandwidth is an important aspectof any local-averaging technique and is discussed more fully in Section II.C.
Substituting equation ~8! into equation ~4! yields the NadarayaWatsonkernel estimator [mh~x! of m~x!:
[mh~x! 51
T (t51T
vt, h~x!Yt 5(t51
T
Kh~x 2 Xt !Yt
(t51
T
Kh~x 2 Xt !
. ~9!
Under certain regularity conditions on the shape of the kernel K and themagnitudes and behavior of the weights as the sample size grows, it may beshown that [mh~x! converges to m~x! asymptotically in several ways ~seeHrdle ~1990! for further details!. This convergence property holds for awide class of kernels, but for the remainder of this paper we shall use themost popular choice of kernel, the Gaussian kernel:
Kh~x! 51
h%2pe2x
202h2 ~10!
C. Selecting the Bandwidth
Selecting the appropriate bandwidth h in equation ~9! is clearly central tothe success of [mh~{! in approximating m~{!too little averaging yields afunction that is too choppy, and too much averaging yields a function that istoo smooth. To illustrate these two extremes, Figure 2 displays the NadarayaWatson kernel estimator applied to 500 data points generated from the relation:
Yt 5 Sin~Xt ! 1 0.5eZt , eZt ; N ~0,1!, ~11!
where Xt is evenly spaced in the interval @0,2p# . Panel 2 ~a! plots the rawdata and the function to be approximated.
Foundations of Technical Analysis 1711
(a)
(b)
Figure 2. Illustration of bandwidth selection for kernel regression.
1712 The Journal of Finance
(c)
(d)
Figure 2. Continued
Foundations of Technical Analysis 1713
Kernel estimators for three different bandwidths are plotted as solid lines inPanels 2~b!~c!. The bandwidth in 2~b! is clearly too small; the function is toovariable, fitting the noise 0.5eZt and also the signal Sin~{!. Increasing thebandwidth slightly yields a much more accurate approximation to Sin ~{! asPanel 2~c! illustrates. However, Panel 2~d! shows that if the bandwidth is in-creased beyond some point, there is too much averaging and information is lost.
There are several methods for automating the choice of bandwidth h inequation ~9!, but the most popular is the cross-validation method in which his chosen to minimize the cross-validation function
CV~h! 51
T (t51T
~Pt 2 [mh, t !2, ~12!
where
[mh, t [1
T (ttT
vt, hYt . ~13!
The estimator [mh, t is the kernel regression estimator applied to the pricehistory $Pt% with the tth observation omitted, and the summands in equa-tion ~12! are the squared errors of the [mh, ts, each evaluated at the omittedobservation. For a given bandwidth parameter h, the cross-validation func-tion is a measure of the ability of the kernel regression estimator to fit eachobservation Pt when that observation is not used to construct the kernelestimator. By selecting the bandwidth that minimizes this function, we ob-tain a kernel estimator that satisfies certain optimality properties, for ex-ample, minimum asymptotic mean-squared error.4
Interestingly, the bandwidths obtained from minimizing the cross-validationfunction are generally too large for our application to technical analysiswhen we presented several professional technical analysts with plots of cross-validation-fitted functions [mh~{!, they all concluded that the fitted functionswere too smooth. In other words, the cross-validation-determined bandwidthplaces too much weight on prices far away from any given time t, inducingtoo much averaging and discarding valuable information in local price move-ments. Through trial and error, and by polling professional technical ana-lysts, we have found that an acceptable solution to this problem is to use abandwidth of 0.3 3 h*, where h* minimizes CV~h!.5 Admittedly, this is an adhoc approach, and it remains an important challenge for future research todevelop a more rigorous procedure.
4 However, there are other bandwidth-selection methods that yield the same asymptotic op-timality properties but that have different implications for the finite-sample properties of ker-nel estimators. See Hrdle ~1990! for further discussion.
5 Specifically, we produced fitted curves for various bandwidths and compared their extremato the original price series visually to see if we were fitting more noise than signal, and weasked several professional technical analysts to do the same. Through this informal process, wesettled on the bandwidth of 0.3 3 h* and used it for the remainder of our analysis. This pro-cedure was followed before we performed the statistical analysis of Section III, and we made norevision to the choice of bandwidth afterward.
1714 The Journal of Finance
Another promising direction for future research is to consider alternativesto kernel regression. Although kernel regression is useful for its simplicityand intuitive appeal, kernel estimators suffer from a number of well-knowndeficiencies, for instance, boundary bias, lack of local variability in the de-gree of smoothing, and so on. A popular alternative that overcomes theseparticular deficiencies is local polynomial regression in which local averag-ing of polynomials is performed to obtain an estimator of m~x!.6 Such alter-natives may yield important improvements in the pattern-recognitionalgorithm described in Section II.
II. Automating Technical Analysis
Armed with a mathematical representation [m~{! of $Pt % with which geo-metric properties can be characterized in an objective manner, we can nowconstruct an algorithm for automating the detection of technical patterns.Specifically, our algorithm contains three steps:
1. Define each technical pattern in terms of its geometric properties, forexample, local extrema ~maxima and minima!.
2. Construct a kernel estimator [m~{! of a given time series of prices sothat its extrema can be determined numerically.
3. Analyze [m~{! for occurrences of each technical pattern.
The last two steps are rather straightforward applications of kernel regres-sion. The first step is likely to be the most controversial because it is herethat the skills and judgment of a professional technical analyst come intoplay. Although we will argue in Section II.A that most technical indicatorscan be characterized by specific sequences of local extrema, technical ana-lysts may argue that these are poor approximations to the kinds of patternsthat trained human analysts can identify.
While pattern-recognition techniques have been successful in automatinga number of tasks previously considered to be uniquely human endeavorsfingerprint identification, handwriting analysis, face recognition, and so onnevertheless it is possible that no algorithm can completely capture the skillsof an experienced technical analyst. We acknowledge that any automatedprocedure for pattern recognition may miss some of the more subtle nuancesthat human cognition is capable of discerning, but whether an algorithm isa poor approximation to human judgment can only be determined by inves-tigating the approximation errors empirically. As long as an algorithm canprovide a reasonable approximation to some of the cognitive abilities of ahuman analyst, we can use such an algorithm to investigate the empiricalperformance of those aspects of technical analysis for which the algorithm isa good approximation. Moreover, if technical analysis is an art form that can
6 See Simonoff ~1996! for a discussion of the problems with kernel estimators and alterna-tives such as local polynomial regression.
Foundations of Technical Analysis 1715
be taught, then surely its basic precepts can be quantified and automated tosome degree. And as increasingly sophisticated pattern-recognition tech-niques are developed, a larger fraction of the art will become a science.
More important, from a practical perspective, there may be significantbenefits to developing an algorithmic approach to technical analysis becauseof the leverage that technology can provide. As with many other successfultechnologies, the automation of technical pattern recognition may not re-place the skills of a technical analyst but can amplify them considerably.
In Section II.A, we propose definitions of 10 technical patterns based ontheir extrema. In Section II.B, we describe a specific algorithm to identifytechnical patterns based on the local extrema of price series using kernelregression estimators, and we provide specific examples of the algorithm atwork in Section II.C.
A. Definitions of Technical Patterns
We focus on five pairs of technical patterns that are among the most popularpatterns of traditional technical analysis ~see, e.g., Edwards and Magee ~1966,Chaps. VIIX!!: head-and-shoulders ~HS! and inverse head-and-shoulders ~IHS!,broadening tops ~BTOP! and bottoms ~BBOT!, triangle tops ~TTOP! and bot-toms ~TBOT!, rectangle tops ~RTOP! and bottoms ~RBOT!, and double tops~DTOP! and bottoms ~DBOT!. There are many other technical indicators thatmay be easier to detect algorithmicallymoving averages, support and resis-tance levels, and oscillators, for examplebut because we wish to illustratethe power of smoothing techniques in automating technical analysis, we focuson precisely those patterns that are most difficult to quantify analytically.
Consider the systematic component m~{! of a price history $Pt % and sup-pose we have identified n local extrema, that is, the local maxima andminima, of $Pt %. Denote by E1, E2, . . . , En the n extrema and t1
* , t2* , . . . , tn
* thedates on which these extrema occur. Then we have the following definitions.
Definition 1 (Head-and-Shoulders) Head-and-shoulders ~HS! and in-verted head-and-shoulders ~IHS! patterns are characterized by a sequence offive consecutive local extrema E1, . . . , E5 such that
HS [ 5E1 is a maximum
E3 . E1, E3 . E5
E1 and E5 are within 1.5 percent of their average
E2 and E4 are within 1.5 percent of their average,
IHS [ 5E1 is a minimum
E3 , E1, E3 , E5
E1 and E5 are within 1.5 percent of their average
E2 and E4 are within 1.5 percent of their average.
1716 The Journal of Finance
Observe that only five consecutive extrema are required to identify a head-and-shoulders pattern. This follows from the formalization of the geometryof a head-and-shoulders pattern: three peaks, with the middle peak higherthan the other two. Because consecutive extrema must alternate betweenmaxima and minima for smooth functions,7 the three-peaks pattern corre-sponds to a sequence of five local extrema: maximum, minimum, highestmaximum, minimum, and maximum. The inverse head-and-shoulders is sim-ply the mirror image of the head-and-shoulders, with the initial local ex-trema a minimum.
Because broadening, rectangle, and triangle patterns can begin on eithera local maximum or minimum, we allow for both of these possibilities in ourdefinitions by distinguishing between broadening tops and bottoms.
Definition 2 (Broadening) Broadening tops ~BTOP! and bottoms ~BBOT!are characterized by a sequence of five consecutive local extrema E1, . . . , E5such that
BTOP [ 5E1 is a maximum
E1 , E3 , E5
E2 . E4
, BBOT [ 5E1 is a minimum
E1 . E3 . E5
E2 , E4
.
Definitions for triangle and rectangle patterns follow naturally.
Definition 3 (Triangle) Triangle tops ~TTOP! and bottoms ~TBOT! are char-acterized by a sequence of five consecutive local extrema E1, . . . , E5 such that
TTOP [ 5E1 is a maximum
E1 . E3 . E5
E2 , E4
, TBOT [ 5E1 is a minimum
E1 , E3 , E5
E2 . E4
.
Definition 4 (Rectangle) Rectangle tops ~RTOP! and bottoms ~RBOT! arecharacterized by a sequence of five consecutive local extrema E1, . . . , E5 suchthat
RTOP [ 5E1 is a maximum
tops are within 0.75 percent of their average
bottoms are within 0.75 percent of their average
lowest top . highest bottom,
7 After all, for two consecutive maxima to be local maxima, there must be a local minimumin between and vice versa for two consecutive minima.
Foundations of Technical Analysis 1717
RBOT [ 5E1 is a minimum
tops are within 0.75 percent of their average
bottoms are within 0.75 percent of their average
lowest top . highest bottom.
The definition for double tops and bottoms is slightly more involved. Con-sider first the double top. Starting at a local maximum E1, we locate thehighest local maximum Ea occurring after E1 in the set of all local extremain the sample. We require that the two tops, E1 and Ea, be within 1.5 percentof their average. Finally, following Edwards and Magee ~1966!, we requirethat the two tops occur at least a month, or 22 trading days, apart. There-fore, we have the following definition.
Definition 5 (Double Top and Bottom) Double tops ~DTOP! and bottoms~DBOT! are characterized by an initial local extremum E1 and subsequentlocal extrema Ea and Eb such that
Ea [ sup $Ptk* : tk
* . t1* , k 5 2, . . . , n%
Eb [ inf $Ptk* : tk
* . t1* , k 5 2, . . . , n%
and
DTOP [ 5E1 is a maximum
E1 and Ea are within 1.5 percent of their average
ta*2 t1
* . 22
DBOT [ 5E1 is a minimum
E1 and Eb are within 1.5 percent of their average
ta*2 t1
* . 22
B. The Identification Algorithm
Our algorithm begins with a sample of prices $P1, . . . , PT % for which we fitkernel regressions, one for each subsample or window from t to t 1 l 1 d 2 1,where t varies from 1 to T 2 l 2 d 1 1, and l and d are fixed parameterswhose purpose is explained below. In the empirical analysis of Section III,we set l 5 35 and d 5 3; hence each window consists of 38 trading days.
The motivation for fitting kernel regressions to rolling windows of data isto narrow our focus to patterns that are completed within the span of thewindowl 1 d trading days in our case. If we fit a single kernel regressionto the entire dataset, many patterns of various durations may emerge, andwithout imposing some additional structure on the nature of the patterns, it
1718 The Journal of Finance
is virtually impossible to distinguish signal from noise in this case. There-fore, our algorithm fixes the length of the window at l 1 d, but kernel re-gressions are estimated on a rolling basis and we search for patterns in eachwindow.
Of course, for any fixed window, we can only find patterns that are com-pleted within l 1 d trading days. Without further structure on the system-atic component of prices m~{!, this is a restriction that any empirical analysismust contend with.8 We choose a shorter window length of l 5 35 tradingdays to focus on short-horizon patterns that may be more relevant for activeequity traders, and we leave the analysis of longer-horizon patterns to fu-ture research.
The parameter d controls for the fact that in practice we do not observe arealization of a given pattern as soon as it has completed. Instead, we as-sume that there may be a lag between the pattern completion and the timeof pattern detection. To account for this lag, we require that the final extre-mum that completes a pattern occurs on day t 1 l 2 1; hence d is the numberof days following the completion of a pattern that must pass before the pat-tern is detected. This will become more important in Section III when wecompute conditional returns, conditioned on the realization of each pattern.In particular, we compute postpattern returns starting from the end of trad-ing day t 1 l 1 d, that is, one day after the pattern has completed. Forexample, if we determine that a head-and-shoulder pattern has completedon day t 1 l 2 1 ~having used prices from time t through time t 1 l 1 d 2 1!,we compute the conditional one-day gross return as Z1 [ Yt1l1d110Yt1l1d .Hence we do not use any forward information in computing returns condi-tional on pattern completion. In other words, the lag d ensures that we arecomputing our conditional returns completely out-of-sample and without anylook-ahead bias.
Within each window, we estimate a kernel regression using the prices inthat window, hence:
[mh~t! 5(s5t
t1l1d21
Kh~t 2 s!Ps
(s5t
t1l1d21
Kh~t 2 s!
, t 5 1, . . . ,T 2 l 2 d 1 1, ~14!
where Kh~z! is given in equation ~10! and h is the bandwidth parameter ~seeSec. II.C!. It is clear that [mh~t! is a differentiable function of t.
Once the function [mh~t! has been computed, its local extrema can be readilyidentified by finding times t such that Sgn~ [mh' ~t!! 5 2Sgn~ [mh' ~t 1 1!!, where[mh' denotes the derivative of [mh with respect to t and Sgn~{! is the signum
function. If the signs of [mh' ~t! and [mh
' ~t 1 1! are 11 and 21, respectively, then
8 If we are willing to place additional restrictions on m~{!, for example, linearity, we canobtain considerably more accurate inferences even for partially completed patterns in any fixedwindow.
Foundations of Technical Analysis 1719
we have found a local maximum, and if they are 21 and 11, respectively, thenwe have found a local minimum. Once such a time t has been identified, weproceed to identify a maximum or minimum in the original price series $Pt % inthe range @t 2 1, t 1 1# , and the extrema in the original price series are usedto determine whether or not a pattern has occurred according to the defini-tions of Section II.A.
If [mh' ~t! 5 0 for a given t, which occurs if closing prices stay the same for
several consecutive days, we need to check whether the price we have foundis a local minimum or maximum. We look for the date s such that s 5 inf $s .t : [mh
' ~s! 0% . We then apply the same method as discussed above, excepthere we compare Sgn~ [mh' ~t 2 1!! and Sgn~ [mh' ~s!!.
One useful consequence of this algorithm is that the series of extrema thatit identifies contains alternating minima and maxima. That is, if the kthextremum is a maximum, then it is always the case that the ~k 1 1!th ex-tremum is a minimum and vice versa.
An important advantage of using this kernel regression approach to iden-tify patterns is the fact that it ignores extrema that are too local. For exam-ple, a simpler alternative is to identify local extrema from the raw price datadirectly, that is, identify a price Pt as a local maximum if Pt21 , Pt and Pt . Pt11and vice versa for a local minimum. The problem with this approach is that itidentifies too many extrema and also yields patterns that are not visually con-sistent with the kind of patterns that technical analysts find compelling.
Once we have identified all of the local extrema in the window @t, t 1 l 1d 2 1# , we can proceed to check for the presence of the various technicalpatterns using the definitions of Section II.A. This procedure is then re-peated for the next window @t 1 1, t 1 l 1 d # and continues until the end ofthe sample is reached at the window @T 2 l 2 d 1 1,T # .
C. Empirical Examples
To see how our algorithm performs in practice, we apply it to the dailyreturns of a single security, CTX, during the five-year period from 1992 to1996. Figures 37 plot occurrences of the five pairs of patterns defined inSection II.A that were identified by our algorithm. Note that there were norectangle bottoms detected for CTX during this period, so for completenesswe substituted a rectangle bottom for CDO stock that occurred during thesame period.
In each of these graphs, the solid lines are the raw prices, the dashed linesare the kernel estimators [mh~{!, the circles indicate the local extrema, andthe vertical line marks date t 1 l 2 1, the day that the final extremumoccurs to complete the pattern.
Casual inspection by several professional technical analysts seems to con-firm the ability of our automated procedure to match human judgment inidentifying the five pairs of patterns in Section II.A. Of course, this is merelyanecdotal evidence and not meant to be conclusivewe provide these fig-ures simply to illustrate the output of a technical pattern-recognition algo-rithm based on kernel regression.
1720 The Journal of Finance
(a) Head-and-Shoulders
(b) Inverse Head-and-Shoulders
Figure 3. Head-and-shoulders and inverse head-and-shoulders.
Foundations of Technical Analysis 1721
(a) Broadening Top
(b) Broadening Bottom
Figure 4. Broadening tops and bottoms.
1722 The Journal of Finance
(a) Triangle Top
(b) Triangle Bottom
Figure 5. Triangle tops and bottoms.
Foundations of Technical Analysis 1723
(a) Rectangle Top
(b) Rectangle Bottom
Figure 6. Rectangle tops and bottoms.
1724 The Journal of Finance
(a) Double Top
(b) Double Bottom
Figure 7. Double tops and bottoms.
Foundations of Technical Analysis 1725
III. Is Technical Analysis Informative?
Although there have been many tests of technical analysis over the years,most of these tests have focused on the profitability of technical tradingrules.9 Although some of these studies do find that technical indicators cangenerate statistically significant trading profits, but they beg the questionof whether or not such profits are merely the equilibrium rents that accrueto investors willing to bear the risks associated with such strategies. With-out specifying a fully articulated dynamic general equilibrium asset-pricingmodel, it is impossible to determine the economic source of trading profits.
Instead, we propose a more fundamental test in this section, one thatattempts to gauge the information content in the technical patterns of Sec-tion II.A by comparing the unconditional empirical distribution of returnswith the corresponding conditional empirical distribution, conditioned on theoccurrence of a technical pattern. If technical patterns are informative, con-ditioning on them should alter the empirical distribution of returns; if theinformation contained in such patterns has already been incorporated intoreturns, the conditional and unconditional distribution of returns should beclose. Although this is a weaker test of the effectiveness of technical analy-sisinformativeness does not guarantee a profitable trading strategyit is,nevertheless, a natural first step in a quantitative assessment of technicalanalysis.
To measure the distance between the two distributions, we propose twogoodness-of-fit measures in Section III.A. We apply these diagnostics to thedaily returns of individual stocks from 1962 to 1996 using a procedure de-scribed in Sections III.B to III.D, and the results are reported in Sec-tions III.E and III.F.
A. Goodness-of-Fit Tests
A simple diagnostic to test the informativeness of the 10 technical pat-terns is to compare the quantiles of the conditional returns with their un-conditional counterparts. If conditioning on these technical patterns providesno incremental information, the quantiles of the conditional returns shouldbe similar to those of unconditional returns. In particular, we compute the
9 For example, Chang and Osler ~1994! and Osler and Chang ~1995! propose an algorithm forautomatically detecting head-and-shoulders patterns in foreign exchange data by looking atproperly defined local extrema. To assess the efficacy of a head-and-shoulders trading rule, theytake a stand on a class of trading strategies and compute the profitability of these across asample of exchange rates against the U.S. dollar. The null return distribution is computed by abootstrap that samples returns randomly from the original data so as to induce temporal in-dependence in the bootstrapped time series. By comparing the actual returns from tradingstrategies to the bootstrapped distribution, the authors find that for two of the six currenciesin their sample ~the yen and the Deutsche mark!, trading strategies based on a head-and-shoulders pattern can lead to statistically significant profits. See, also, Neftci and Policano~1984!, Pruitt and White ~1988!, and Brock et al. ~1992!.
1726 The Journal of Finance
deciles of unconditional returns and tabulate the relative frequency Zdj ofconditional returns falling into decile j of the unconditional returns, j 51, . . . ,10:
Zdj [number of conditional returns in decile j
total number of conditional returns. ~15!
Under the null hypothesis that the returns are independently and identi-cally distributed ~IID! and the conditional and unconditional distributionsare identical, the asymptotic distributions of Zdj and the corresponding goodness-of-fit test statistic Q are given by
!n~ Zdj 2 0.10! ;a N ~0,0.10~1 2 0.10!!, ~16!
Q [ (j51
10 ~nj 2 0.10n!2
0.10n;a
x92, ~17!
where nj is the number of observations that fall in decile j and n is the totalnumber of observations ~see, e.g., DeGroot ~1986!!.
Another comparison of the conditional and unconditional distributions ofreturns is provided by the KolmogorovSmirnov test. Denote by $Z1t %t51
n1 and$Z2t %t51
n2 two samples that are each IID with cumulative distribution func-tions F1~z! and F2~z!, respectively. The KolmogorovSmirnov statistic is de-signed to test the null hypothesis that F1 5 F2 and is based on the empiricalcumulative distribution functions ZFi of both samples:
ZFi ~z! [1
ni(k51
ni
1~Zik # z!, i 5 1,2, ~18!
where 1~{! is the indicator function. The statistic is given by the expression
gn1, n2 5 S n1 n2n1 1 n2D102
sup2`,z,`
6 ZF1~z! 2 ZF2~z!6. ~19!
Under the null hypothesis F1 5 F2, the statistic gn1, n2 should be small. More-over, Smirnov ~1939a, 1939b! derives the limiting distribution of the statisticto be
limmin~n1, n2!r`
Prob~gn1, n2 # x! 5 (k52`
`
~21!k exp~22k2x 2 !, x . 0. ~20!
Foundations of Technical Analysis 1727
An approximate a-level test of the null hypothesis can be performed by com-puting the statistic and rejecting the null if it exceeds the upper 100athpercentile for the null distribution given by equation ~20! ~see Hollander andWolfe ~1973, Table A.23!, Cski ~1984!, and Press et al. ~1986, Chap. 13.5!!.
Note that the sampling distributions of both the goodness-of-f it andKolmogorovSmirnov statistics are derived under the assumption that re-turns are IID, which is not plausible for financial data. We attempt to ad-dress this problem by normalizing the returns of each security, that is, bysubtracting its mean and dividing by its standard deviation ~see Sec. III.C!,but this does not eliminate the dependence or heterogeneity. We hope toextend our analysis to the more general non-IID case in future research.
B. The Data and Sampling Procedure
We apply the goodness-of-fit and KolmogorovSmirnov tests to the dailyreturns of individual NYSE0AMEX and Nasdaq stocks from 1962 to 1996using data from the Center for Research in Securities Prices ~CRSP!. Toameliorate the effects of nonstationarities induced by changing market struc-ture and institutions, we split the data into NYSE0AMEX stocks and Nas-daq stocks and into seven five-year periods: 1962 to 1966, 1967 to 1971,and so on. To obtain a broad cross section of securities, in each five-yearsubperiod, we randomly select 10 stocks from each of f ive market-capitalization quintiles ~using mean market capitalization over the subperi-od!, with the further restriction that at least 75 percent of the priceobservations must be nonmissing during the subperiod.10 This procedureyields a sample of 50 stocks for each subperiod across seven subperiods~note that we sample with replacement; hence there may be names incommon across subperiods!.
As a check on the robustness of our inferences, we perform this samplingprocedure twice to construct two samples, and we apply our empirical analy-sis to both. Although we report results only from the first sample to con-serve space, the results of the second sample are qualitatively consistentwith the first and are available upon request.
C. Computing Conditional Returns
For each stock in each subperiod, we apply the procedure outlined in Sec-tion II to identify all occurrences of the 10 patterns defined in Section II.A.For each pattern detected, we compute the one-day continuously com-pounded return d days after the pattern has completed. Specifically, con-sider a window of prices $Pt % from t to t 1 l 1 d 2 1 and suppose that the
10 If the first price observation of a stock is missing, we set it equal to the first nonmissingprice in the series. If the tth price observation is missing, we set it equal to the first nonmissingprice prior to t.
1728 The Journal of Finance
identified pattern p is completed at t 1 l 2 1. Then we take the conditionalreturn R p as log~1 1 Rt1l1d11!. Therefore, for each stock, we have 10 sets ofsuch conditional returns, each conditioned on one of the 10 patterns ofSection II.A.
For each stock, we construct a sample of unconditional continuously com-pounded returns using nonoverlapping intervals of length t, and we comparethe empirical distribution functions of these returns with those of the con-ditional returns. To facilitate such comparisons, we standardize all returnsboth conditional and unconditionalby subtracting means and dividing bystandard deviations, hence:
Xit 5Rit 2 Mean@Rit #
SD@Rit #, ~21!
where the means and standard deviations are computed for each individualstock within each subperiod. Therefore, by construction, each normalizedreturn series has zero mean and unit variance.
Finally, to increase the power of our goodness-of-fit tests, we combine thenormalized returns of all 50 stocks within each subperiod; hence for eachsubperiod we have two samplesunconditional and conditional returnsand from these we compute two empirical distribution functions that wecompare using our diagnostic test statistics.
D. Conditioning on Volume
Given the prominent role that volume plays in technical analysis, we alsoconstruct returns conditioned on increasing or decreasing volume. Specifi-cally, for each stock in each subperiod, we compute its average share turn-over during the first and second halves of each subperiod, t1 and t2,respectively. If t1 . 1.2 3 t2, we categorize this as a decreasing volumeevent; if t2 . 1.2 3 t1, we categorize this as an increasing volume event. Ifneither of these conditions holds, then neither event is considered to haveoccurred.
Using these events, we can construct conditional returns conditioned ontwo pieces of information: the occurrence of a technical pattern and the oc-currence of increasing or decreasing volume. Therefore, we shall comparethe empirical distribution of unconditional returns with three conditional-return distributions: the distribution of returns conditioned on technical pat-terns, the distribution conditioned on technical patterns and increasing volume,and the distribution conditioned on technical patterns and decreasing volume.
Of course, other conditioning variables can easily be incorporated into thisprocedure, though the curse of dimensionality imposes certain practicallimits on the ability to estimate multivariate conditional distributionsnonparametrically.
Foundations of Technical Analysis 1729
E. Summary Statistics
In Tables I and II, we report frequency counts for the number of patternsdetected over the entire 1962 to 1996 sample, and within each subperiod andeach market-capitalization quintile, for the 10 patterns defined in Sec-tion II.A. Table I contains results for the NYSE0AMEX stocks, and Table IIcontains corresponding results for Nasdaq stocks.
Table I shows that the most common patterns across all stocks and overthe entire sample period are double tops and bottoms ~see the row labeledEntire!, with over 2,000 occurrences of each. The second most commonpatterns are the head-and-shoulders and inverted head-and-shoulders, withover 1,600 occurrences of each. These total counts correspond roughly to fourto six occurrences of each of these patterns for each stock during each five-year subperiod ~divide the total number of occurrences by 7 3 50!, not anunreasonable frequency from the point of view of professional technical an-alysts. Table I shows that most of the 10 patterns are more frequent forlarger stocks than for smaller ones and that they are relatively evenly dis-tributed over the five-year subperiods. When volume trend is consideredjointly with the occurrences of the 10 patterns, Table I shows that the fre-quency of patterns is not evenly distributed between increasing ~the rowlabeled t~;!! and decreasing ~the row labeled t~'!! volume-trend cases.For example, for the entire sample of stocks over the 1962 to 1996 sampleperiod, there are 143 occurrences of a broadening top with decreasing vol-ume trend but 409 occurrences of a broadening top with increasing volumetrend.
For purposes of comparison, Table I also reports frequency counts for thenumber of patterns detected in a sample of simulated geometric Brownianmotion, calibrated to match the mean and standard deviation of each stockin each five-year subperiod.11 The entries in the row labeled Sim. GBMshow that the random walk model yields very different implications for thefrequency counts of several technical patterns. For example, the simulatedsample has only 577 head-and-shoulders and 578 inverted-head-and-shoulders patterns, whereas the actual data have considerably more, 1,611and 1,654, respectively. On the other hand, for broadening tops and bottoms,the simulated sample contains many more occurrences than the actual data,1,227 and 1,028, compared to 725 and 748, respectively. The number of tri-angles is roughly comparable across the two samples, but for rectangles and
11 In particular, let the price process satisfy
dP~t! 5 mP~t!dt 1 sP~t!dW~t!,
where W~t! is a standard Brownian motion. To generate simulated prices for a single securityin a given period, we estimate the securitys drift and diffusion coefficients by maximum like-lihood and then simulate prices using the estimated parameter values. An independent priceseries is simulated for each of the 350 securities in both the NYSE0AMEX and the Nasdaqsamples. Finally, we use our pattern-recognition algorithm to detect the occurrence of each ofthe 10 patterns in the simulated price series.
1730 The Journal of Finance
double tops and bottoms, the differences are dramatic. Of course, the simu-lated sample is only one realization of geometric Brownian motion, so it isdifficult to draw general conclusions about the relative frequencies. Never-theless, these simulations point to important differences between the dataand IID lognormal returns.
To develop further intuition for these patterns, Figures 8 and 9 display thecross-sectional and time-series distribution of each of the 10 patterns for theNYSE0AMEX and Nasdaq samples, respectively. Each symbol represents apattern detected by our algorithm, the vertical axis is divided into the fivesize quintiles, the horizontal axis is calendar time, and alternating symbols~diamonds and asterisks! represent distinct subperiods. These graphs showthat the distribution of patterns is not clustered in time or among a subsetof securities.
Table II provides the same frequency counts for Nasdaq stocks, and de-spite the fact that we have the same number of stocks in this sample ~50 persubperiod over seven subperiods!, there are considerably fewer patterns de-tected than in the NYSE0AMEX case. For example, the Nasdaq sample yieldsonly 919 head-and-shoulders patterns, whereas the NYSE0AMEX samplecontains 1,611. Not surprisingly, the frequency counts for the sample of sim-ulated geometric Brownian motion are similar to those in Table I.
Tables III and IV report summary statisticsmeans, standard deviations,skewness, and excess kurtosisof unconditional and conditional normalizedreturns of NYSE0AMEX and Nasdaq stocks, respectively. These statisticsshow considerable variation in the different return populations. For exam-ple, in Table III the first four moments of normalized raw returns are 0.000,1.000, 0.345, and 8.122, respectively. The same four moments of post-BTOPreturns are 20.005, 1.035, 21.151, and 16.701, respectively, and those ofpost-DTOP returns are 0.017, 0.910, 0.206, and 3.386, respectively. The dif-ferences in these statistics among the 10 conditional return populations, andthe differences between the conditional and unconditional return popula-tions, suggest that conditioning on the 10 technical indicators does havesome effect on the distribution of returns.
F. Empirical Results
Tables V and VI report the results of the goodness-of-fit test ~equations~16! and ~17!! for our sample of NYSE and AMEX ~Table V! and Nasdaq~Table VI! stocks, respectively, from 1962 to 1996 for each of the 10 technicalpatterns. Table V shows that in the NYSE0AMEX sample, the relative fre-quencies of the conditional returns are significantly different from those ofthe unconditional returns for seven of the 10 patterns considered. The threeexceptions are the conditional returns from the BBOT, TTOP, and DBOTpatterns, for which the p-values of the test statistics Q are 5.1 percent, 21.2percent, and 16.6 percent, respectively. These results yield mixed supportfor the overall efficacy of technical indicators. However, the results of Table VItell a different story: there is overwhelming significance for all 10 indicators
Foundations of Technical Analysis 1731
Tab
leI
Fre
quen
cyco
un
tsfo
r10
tech
nic
alin
dica
tors
dete
cted
amon
gN
YS
E0A
ME
Xst
ocks
from
1962
to19
96,
infi
ve-y
ear
subp
erio
ds,
insi
zequ
inti
les,
and
ina
sam
ple
ofsi
mu
late
dge
omet
ric
Bro
wn
ian
mot
ion
.In
each
five
-yea
rsu
bper
iod,
10st
ocks
per
quin
tile
are
sele
cted
atra
ndo
mam
ong
stoc
ksw
ith
atle
ast
80%
non
mis
sin
gpr
ices
,an
dea
chst
ock
spr
ice
his
tory
issc
ann
edfo
ran
yoc
curr
ence
ofth
efo
llow
ing
10te
chn
ical
indi
cato
rsw
ith
inth
esu
bper
iod:
hea
d-an
d-sh
ould
ers
~HS
!,in
vert
edh
ead-
and-
shou
lder
s~I
HS
!,br
oade
nin
gto
p~B
TO
P!,
broa
den
ing
bott
om~B
BO
T!,
tria
ngl
eto
p~T
TO
P!,
tria
ngl
ebo
ttom
~TB
OT
!,re
ctan
gle
top
~RT
OP
!,re
ctan
gle
bott
om~R
BO
T!,
dou
ble
top
~DT
OP
!,an
ddo
ubl
ebo
ttom
~DB
OT
!.T
he
Sam
ple
colu
mn
indi
cate
sw
het
her
the
freq
uen
cyco
un
tsar
eco
ndi
tion
edon
decr
easi
ng
volu
me
tren
d~t
~ '!
!,in
crea
sin
gvo
lum
etr
end
~t~ ;
!!,
un
con
di-
tion
al~
En
tire
!,
orfo
ra
sam
ple
ofsi
mu
late
dge
omet
ric
Bro
wn
ian
mot
ion
wit
hpa
ram
eter
sca
libr
ated
tom
atch
the
data
~S
im.
GB
M!
.
Sam
ple
Raw
HS
IHS
BT
OP
BB
OT
TT
OP
TB
OT
RT
OP
RB
OT
DT
OP
DB
OT
All
Sto
cks,
1962
to19
96E
nti
re42
3,55
616
1116
5472
574
812
9411
9314
8216
1620
7620
75S
im.
GB
M42
3,55
657
757
812
2710
2810
4911
7612
211
353
557
4t
~ '!
65
559
314
322
066
671
058
263
769
197
4t
~ ;!
55
361
440
933
730
022
252
355
277
653
3
Sm
alle
stQ
uin
tile
,19
62to
1996
En
tire
84,3
6318
218
178
9720
315
926
532
026
127
1S
im.
GB
M84
,363
8299
279
256
269
295
1816
129
127
t~ '
!
9081
1342
122
119
113
131
7816
1t
~ ;!
58
7651
3741
2299
120
124
64
2nd
Qu
inti
le,
1962
to19
96E
nti
re83
,986
309
321
146
150
255
228
299
322
372
420
Sim
.G
BM
83,9
8610
810
529
125
126
127
820
1710
612
6t
~ '!
13
312
625
4813
514
713
014
911
321
1t
~ ;!
11
212
690
6355
3910
411
015
310
7
3rd
Qu
inti
le,
1962
to19
96E
nti
re84
,420
361
388
145
161
291
247
334
399
458
443
Sim
.G
BM
84,4
2012
212
026
822
221
224
924
3111
512
5t
~ '!
15
213
120
4915
114
913
016
015
421
5t
~ ;!
12
514
683
6667
4412
114
217
910
6
4th
Qu
inti
le,
1962
to19
96E
nti
re84
,780
332
317
176
173
262
255
259
264
424
420
Sim
.G
BM
84,7
8014
312
724
921
018
321
035
2411
612
2t
~ '!
13
111
536
4213
814
585
9714
418
4t
~ ;!
11
012
610
389
5655
102
9614
711
8
Lar
gest
Qu
inti
le,
1962
to19
96E
nti
re86
,007
427
447
180
167
283
304
325
311
561
521
Sim
.G
BM
86,0
0712
212
714
089
124
144
2525
6974
t~ '
!
149
140
4939
120
150
124
100
202
203
t~ ;
!
148
140
8282
8162
9784
173
138
1732 The Journal of Finance
All
Sto
cks,
1962
to19
66E
nti
re55
,254
276
278
8510
317
916
531
635
435
635
2S
im.
GB
M55
,254
5658
144
126
129
139
916
6068
t~ '
!
104
8826
2993
109
130
141
113
188
t~ ;
!
9611
244
3937
2513
012
213
788
All
Sto
cks,
1967
to19
71E
nti
re60
,299
179
175
112
134
227
172
115
117
239
258
Sim
.G
BM
60,2
9992
7016
714
815
018
019
1684
77t
~ '!
68
6416
4512
611
142
3980
143
t~ ;
!
7169
6857
4729
4141
8753
All
Sto
cks,
1972
to19
76E
nti
re59
,915
152
162
8293
165
136
171
182
218
223
Sim
.G
BM
59,9
1575
8518
315
415
617
816
1070
71t
~ '!
64
5516
2388
7860
6453
97t
~ ;!
54
6242
5032
2161
6780
59
All
Sto
cks,
1977
to19
81E
nti
re62
,133
223
206
134
110
188
167
146
182
274
290
Sim
.G
BM
62,1
3383
8824
520
018
821
018
1290
115
t~ '
!
114
6124
3910
097
5460
8214
0t
~ ;!
56
9378
4435
3653
7111
376
All
Sto
cks,
1982
to19
86E
nti
re61
,984
242
256
106
108
182
190
182
207
313
299
Sim
.G
BM
61,9
8411
512
018
814
415
216
931
2399
87t
~ '!
10
110
428
3093
104
7095
109
124
t~ ;
!
8994
5162
4640
7368
116
85
All
Sto
cks,
1987
to19
91E
nti
re61
,780
240
241
104
9818
016
926
025
928
728
5S
im.
GB
M61
,780
6879
168
132
131
150
1110
7668
t~ '
!
9589
1630
8610
110
310
210
513
7t
~ ;!
81
7968
4353
3673
8710
068
All
Sto
cks,
1992
to19
96E
nti
re62
,191
299
336
102
102
173
194
292
315
389
368
Sim
.G
BM
62,1
9188
7813
212
414
315
018
2656
88t
~ '!
10
913
217
2480
110
123
136
149
145
t~ ;
!
106
105
5842
5035
9296
143
104
Foundations of Technical Analysis 1733
Tab
leII
Fre
quen
cyco
un
tsfo
r10
tech
nic
alin
dica
tors
dete
cted
amon
gN
asda
qst
ocks
from
1962
to19
96,
infi
ve-y
ear
subp
erio
ds,
insi
zequ
inti
les,
and
ina
sam
ple
ofsi
mu
late
dge
omet
ric
Bro
wn
ian
mot
ion
.In
each
five
-yea
rsu
bper
iod,
10st
ocks
per
quin
tile
are
sele
cted
atra
ndo
mam
ong
stoc
ksw
ith
atle
ast
80%
non
mis
sin
gpr
ices
,an
dea
chst
ock
spr
ice
his
tory
issc
ann
edfo
ran
yoc
curr
ence
ofth
efo
llow
ing
10te
chn
ical
indi
cato
rsw
ith
inth
esu
bper
iod:
hea
d-an
d-sh
ould
ers
~HS
!,in
vert
edh
ead-
and-
shou
lder
s~I
HS
!,br
oade
nin
gto
p~B
TO
P!,
broa
den
ing
bott
om~B
BO
T!,
tria
ngl
eto
p~T
TO
P!,
tria
ngl
ebo
ttom
~TB
OT
!,re
ctan
gle
top
~RT
OP
!,re
ctan
gle
bott
om~R
BO
T!,
dou
ble
top
~DT
OP
!,an
ddo
ubl
ebo
ttom
~DB
OT
!.T
he
Sam
ple
colu
mn
indi
cate
sw
het
her
the
freq
uen
cyco
un
tsar
eco
ndi
tion
edon
decr
easi
ng
volu
me
tren
d~
t~ '
!!,
incr
easi
ng
volu
me
tren
d~
t~ ;
!!,
un
con
diti
onal
~E
nti
re!
,or
for
asa
mpl
eof
sim
ula
ted
geom
etri
cB
row
nia
nm
otio
nw
ith
para
met
ers
cali
brat
edto
mat
chth
eda
ta~
Sim
.G
BM
!.
Sam
ple
Raw
HS
IHS
BT
OP
BB
OT
TT
OP
TB
OT
RT
OP
RB
OT
DT
OP
DB
OT
All
Sto
cks,
1962
to19
96E
nti
re41
1,01
091
981
741
450
885
078
911
3413
2012
0811
47S
im.
GB
M41
1,01
043
444
712
9711
3911
6913
0996
9156
757
9t
~ '!
40
826
869
133
429
460
488
550
339
580
t~ ;
!
284
325
234
209
185
125
391
461
474
229
Sm
alle
stQ
uin
tile
,19
62to
1996
En
tire
81,7
5484
6441
7311
193
165
218
113
125
Sim
.G
BM
81,7
5485
8434
128
933
436
711
1214
012
5t
~ '!
36
256
2056
5977
102
3181
t~ ;
!
3123
3130
2415
5985
4617
2nd
Qu
inti
le,
1962
to19
96E
nti
re81
,336
191
138
6888
161
148
242
305
219
176
Sim
.G
BM
81,3
3667
8424
322
521
922
924
1299
124
t~ '
!
9451
1128
8610
911
113
169
101
t~ ;
!
6657
4638
4522
8512
090
42
3rd
Qu
inti
le,
1962
to19
96E
nti
re81
,772
224
186
105
121
183
155
235
244
279
267
Sim
.G
BM
81,7
7269
8622
721
021
423
915
1410
510
0t
~ '!
10
866
2335
8791
9084
7814
5t
~ ;!
71
7956
4939
2984
8612
258
4th
Qu
inti
le,
1962
to19
96E
nti
re82
,727
212
214
9211
618
717
929
630
328
929
7S
im.
GB
M82
,727
104
9224
221
920
925
523
2611
597
t~ '
!
8868
1226
101
101
127
141
7714
3t
~ ;!
62
8357
5634
2210
493
118
66
Lar
gest
Qu
inti
le,
1962
to19
96E
nti
re83
,421
208
215
108
110
208
214
196
250
308
282
Sim
.G
BM
83,4
2110
910
124
419
619
321
923
2710
813
3t
~ '!
82
5817
2499
100
8392
8411
0t
~ ;!
54
8344
3643
3759
7798
46
1734 The Journal of Finance
All
Sto
cks,
1962
to19
66E
nti
re55
,969
274
268
7299
182
144
288
329
326
342
Sim
.G
BM
55,9
6969
6316
312
313
714
924
2277
90t
~ '!
12
999
1023
104
9811
513
696
210
t~ ;
!
8310
348
5137
2310
111
614
464
All
Sto
cks,
1967
to19
71E
nti
re60
,563
115
120
104
123
227
171
6583
196
200
Sim
.G
BM
60,5
6358
6119
418
418
118
89
890
83t
~ '!
61
2915
4012
712
326
3949
137
t~ ;
!
2457
7151
4519
2516
8617
All
Sto
cks,
1972
to19
76E
nti
re51
,446
3430
1430
2928
5155
5558
Sim
.G
BM
51,4
4632
3711
511
310
711
05
646
46t
~ '!
5
40
45
712
83
8t
~ ;!
8
71
22
05
128
3
All
Sto
cks,
1977
to19
81E
nti
re61
,972
5653
4136
5273
5765
8996
Sim
.G
BM
61,9
7290
8423
616
517
621
219
1911
098
t~ '
!
77
12
48
1212
79
t~ ;
!
66
51
40
58
76
All
Sto
cks,
1982
to19
86E
nti
re61
,110
7164
4644
9710
710
911
512
097
Sim
.G
BM
61,1
1086
9016
216
814
717
423
2197
98t
~ '!
37
198
1446
5845
5240
48t
~ ;!
21
2524
1826
2242
4238
24
All
Sto
cks,
1987
to19
91E
nti
re60
,862
158
120
5061
120
109
265
312
177
155
Sim
.G
BM
60,8
6259
5722
918
720
524
47
779
88t
~ '!
79
4611
1973
6913
014
050
69t
~ ;!
58
5633
3026
2810
012
289
55
All
Sto
cks,
1992
to19
96E
nti
re59
,088
211
162
8711
514
315
729
936
124
519
9S
im.
GB
M59
,088
4055
198
199
216
232
98
6876
t~ '
!
9064
2431
7097
148
163
9499
t~ ;
!
8471
5256
4533
113
145
102
60
Foundations of Technical Analysis 1735
(a)
(b)
Figure 8. Distribution of patterns in NYSE/AMEX sample.
1736 The Journal of Finance
(c)
(d)
Figure 8. Continued
Foundations of Technical Analysis 1737
~e!
(f)
Figure 8. Continued
1738 The Journal of Finance
(g)
(h)
Figure 8. Continued
Foundations of Technical Analysis 1739
(i)
(j)
Figure 8. Continued
1740 The Journal of Finance
(a)
(b)
Figure 9. Distribution of patterns in Nasdaq sample.
Foundations of Technical Analysis 1741
(c)
(d)
Figure 9. Continued
1742 The Journal of Finance
(e)
(f)
Figure 9. Continued
Foundations of Technical Analysis 1743
(g)
(h)
Figure 9. Continued
1744 The Journal of Finance
(i)
(j)
Figure 9. Continued
Foundations of Technical Analysis 1745
Tab
leII
IS
um
mar
yst
atis
tics
~mea
n,
stan
dard
devi
atio
n,
skew
nes
s,an
dex
cess
kurt
osis
!of
raw
and
con
diti
onal
one-
day
nor
mal
ized
retu
rns
ofN
YS
E0
AM
EX
stoc
ksfr
om19
62to
1996
,in
five
-yea
rsu
bper
iods
,an
din
size
quin
tile
s.C
ondi
tion
alre
turn
sar
ede
fin
edas
the
dail
yre
turn
thre
eda
ysfo
llow
ing
the
con
clu
sion
ofan
occu
rren
ceof
one
of10
tech
nic
alin
dica
tors
:h
ead-
and-
shou
lder
s~H
S!,
inve
rted
hea
d-an
d-sh
ould
ers
~IH
S!,
broa
d-en
ing
top
~BT
OP
!,br
oade
nin
gbo
ttom
~BB
OT
!,tr
ian
gle
top
~TT
OP
!,tr
ian
gle
bott
om~T
BO
T!,
rect
angl
eto
p~R
TO
P!,
rect
angl
ebo
ttom
~RB
OT
!,do
ubl
eto
p~D
TO
P!,
and
dou
ble
bott
om~D
BO
T!.
All
retu
rns
hav
ebe
enn
orm
aliz
edby
subt
ract
ion
ofth
eir
mea
ns
and
divi
sion
byth
eir
stan
dard
devi
atio
ns.
Mom
ent
Raw
HS
IHS
BT
OP
BB
OT
TT
OP
TB
OT
RT
OP
RB
OT
DT
OP
DB
OT
All
Sto
cks,
1962
to19
96M
ean
20.
000
20.
038
0.04
02
0.00
52
0.06
20.
021
20.
009
0.00
90.
014
0.01
72
0.00
1S
.D.
1.00
00.
867
0.93
71.
035
0.97
90.
955
0.95
90.
865
0.88
30.
910
0.99
9S
kew
.0.
345
0.13
50.
660
21.
151
0.09
00.
137
0.64
32
0.42
00.
110
0.20
60.
460
Ku
rt.
8.12
22.
428
4.52
716
.701
3.16
93.
293
7.06
17.
360
4.19
43.
386
7.37
4
Sm
alle
stQ
uin
tile
,19
62to
1996
Mea
n2
0.00
02
0.01
40.
036
20.
093
20.
188
0.03
62
0.02
00.
037
20.
093
0.04
32
0.05
5S
.D.
1.00
00.
854
1.00
20.
940
0.85
00.
937
1.15
70.
833
0.98
60.
950
0.96
2S
kew
.0.
697
0.80
21.
337
21.
771
20.
367
0.86
12.
592
20.
187
0.44
50.
511
0.00
2K
urt
.10
.873
3.87
07.
143
6.70
10.
575
4.18
512
.532
1.79
34.
384
2.58
13.
989
2nd
Qu
inti
le,
1962
to19
96M
ean
20.
000
20.
069
0.14
40.
061
20.
113
0.00
30.
035
0.01
80.
019
0.06
72
0.01
1S
.D.
1.00
00.
772
1.03
11.
278
1.00
40.
913
0.96
50.
979
0.86
80.
776
1.06
9S
kew
.0.
392
0.22
31.
128
23.
296
0.48
52
0.52
90.
166
21.
375
0.45
20.
392
1.72
8K
urt
.7.
836
0.65
76.
734
32.7
503.
779
3.02
44.
987
17.0
403.
914
2.15
115
.544
3rd
Qu
inti
le,
1962
to19
96M
ean
20.
000
20.
048
20.
043
20.
076
20.
056
0.03
60.
012
0.07
50.
028
20.
039
20.
034
S.D
.1.
000
0.88
80.
856
0.89
40.
925
0.97
30.
796
0.79
80.
892
0.95
61.
026
Ske
w.
0.24
62
0.46
50.
107
20.
023
0.23
30.
538
0.16
60.
678
20.
618
0.01
32
0.24
2K
urt
.7.
466
3.23
91.
612
1.02
40.
611
2.99
50.
586
3.01
04.
769
4.51
73.
663
4th
Qu
inti
le,
1962
to19
96M
ean
20.
000
20.
012
0.02
20.
115
0.02
80.
022
20.
014
20.
113
0.06
50.
015
20.
006
S.D
.1.
000
0.96
40.
903
0.99
01.
093
0.98
60.
959
0.85
40.
821
0.85
80.
992
Ske
w.
0.22
20.
055
0.59
20.
458
0.53
72
0.21
72
0.45
62
0.41
50.
820
0.55
02
0.06
2K
urt
.6.
452
1.44
41.
745
1.25
12.
168
4.23
78.
324
4.31
13.
632
1.71
94.
691
Lar
gest
Qu
inti
le,
1962
to19
96M
ean
20.
000
20.
038
0.05
42
0.08
12
0.04
20.
010
20.
049
0.00
90.
060
0.01
80.
067
S.D
.1.
000
0.84
30.
927
0.99
70.
951
0.96
40.
965
0.85
00.
820
0.97
10.
941
Ske
w.
0.17
40.
438
0.18
20.
470
21.
099
0.08
90.
357
20.
167
20.
140
0.01
10.
511
Ku
rt.
7.99
22.
621
3.46
53.
275
6.60
32.
107
2.50
90.
816
3.17
93.
498
5.03
5
1746 The Journal of Finance
All
Sto
cks,
1962
to19
66M
ean
20.
000
0.07
00.
090
0.15
90.
079
20.
033
20.
039
20.
041
0.01
92
0.07
12
0.10
0S
.D.
1.00
00.
797
0.92
50.
825
1.08
51.
068
1.01
10.
961
0.81
40.
859
0.96
2S
kew
.0.
563
0.15
90.
462
0.36
31.
151
20.
158
1.26
42
1.33
72
0.34
12
0.42
72
0.87
6K
urt
.9.
161
0.61
21.
728
0.65
75.
063
2.67
44.
826
17.1
611.
400
3.41
65.
622
All
Sto
cks,
1967
to19
71M
ean
20.
000
20.
044
0.07
92
0.03
52
0.05
60.
025
0.05
72
0.10
10.
110
0.09
30.
079
S.D
.1.
000
0.80
90.
944
0.79
30.
850
0.88
50.
886
0.83
10.
863
1.08
30.
835
Ske
w.
0.34
20.
754
0.66
60.
304
0.08
50.
650
0.69
72
1.39
30.
395
1.36
00.
701
Ku
rt.
5.81
03.
684
2.72
50.
706
0.14
13.
099
1.65
98.
596
3.25
44.
487
1.85
3
All
Sto
cks,
1972
to19
76M
ean
20.
000
20.
035
0.04
30.
101
20.
138
20.
045
20.
010
20.
025
20.
003
20.
051
20.
108
S.D
.1.
000
1.01
50.
810
0.98
50.
918
0.94
50.
922
0.87
00.
754
0.91
40.
903
Ske
w.
0.31
62
0.33
40.
717
20.
699
0.27
22
1.01
40.
676
0.23
40.
199
0.05
62
0.36
6K
urt
.6.
520
2.28
61.
565
6.56
21.
453
5.26
14.
912
3.62
72.
337
3.52
05.
047
All
Sto
cks,
1977
to19
81M
ean
20.
000
20.
138
20.
040
0.07
62
0.11
40.
135
20.
050
20.
004
0.02
60.
042
0.17
8S
.D.
1.00
00.
786
0.86
31.
015
0.98
91.
041
1.01
10.
755
0.95
60.
827
1.09
5S
kew
.0.
466
20.
304
0.05
21.
599
20.
033
0.77
60.
110
20.
084
0.53
40.
761
2.21
4K
urt
.6.
419
1.13
21.
048
4.96
12
0.12
52.
964
0.98
91.
870
2.18
42.
369
15.2
90
All
Sto
cks,
1982
to19
86M
ean
20.
000
20.
099
20.
007
0.01
10.
095
20.
114
20.
067
0.05
00.
005
0.01
12
0.01
3S
.D.
1.00
00.
883
1.00
21.
109
0.95
60.
924
0.80
10.
826
0.93
40.
850
1.02
6S
kew
.0.
460
0.46
40.
441
0.37
22
0.16
50.
473
21.
249
0.23
10.
467
0.52
80.
867
Ku
rt.
6.79
92.
280
6.12
82.
566
2.73
53.
208
5.27
81.
108
4.23
41.
515
7.40
0
All
Sto
cks,
1987
to19
91M
ean
20.
000
20.
037
0.03
32
0.09
12
0.04
00.
053
0.00
30.
040
20.
020
20.
022
20.
017
S.D
.1.
000
0.84
80.
895
0.95
50.
818
0.85
70.
981
0.89
40.
833
0.87
31.
052
Ske
w.
20.
018
20.
526
0.27
20.
108
0.23
10.
165
21.
216
0.29
30.
124
21.
184
20.
368
Ku
rt.
13.4
783.
835
4.39
52.
247
1.46
94.
422
9.58
61.
646
3.97
34.
808
4.29
7
All
Sto
cks,
1992
to19
96M
ean
20.
000
20.
014
0.06
92
0.23
12
0.27
20.
122
0.04
10.
082
0.01
10.
102
20.
016
S.D
.1.
000
0.93
51.
021
1.40
61.
187
0.95
31.
078
0.81
40.
996
0.96
01.
035
Ske
w.
0.30
80.
545
1.30
52
3.98
82
0.50
22
0.19
02.
460
20.
167
20.
129
20.
091
0.37
9K
urt
.8.
683
2.24
96.
684
27.0
223.
947
1.23
512
.883
0.50
66.
399
1.50
73.
358
Foundations of Technical Analysis 1747
Tab
leIV
Su
mm
ary
stat
isti
cs~m
ean
,st
anda
rdde
viat
ion
,sk
ewn
ess,
and
exce
ssku
rtos
is!
ofra
wan
dco
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tion
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daq
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om19
62to
1996
,in
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-yea
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one
of10
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ian
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rect
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rect
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ubl
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Mom
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TT
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RT
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All
Sto
cks,
1962
to19
96M
ean
0.00
02
0.01
60.
042
20.
009
0.00
92
0.02
00.
017
0.05
20.
043
0.00
32
0.03
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.D.
1.00
00.
907
0.99
40.
960
0.99
50.
984
0.93
20.
948
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90.
933
0.88
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kew
.0.
608
20.
017
1.29
00.
397
0.58
60.
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0.71
60.
710
0.75
50.
405
20.
104
Ku
rt.
12.7
283.
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8.77
43.
246
2.