Research

Price Trends and Patterns in Technical Analysis: A Theoretical and Empirical Examination

Co-authored with Paul Weller and Lee Dunham Technical analysis is used extensively by investment professionals as a guide to trading decisions in financial markets. While many trading rules are based upon price patterns in asset prices, we lack convincing explanations of how and why these patterns arise, and why trading rules based on technical analysis are profitable. This paper provides a model that explains the success of certain trading rules that are based on patterns of past prices and shows that it generates new predictions that are consistent with the data. We point to the importance of confirmation bias, which has been shown to play a key role in other types of decision making. Traders who acquire information about particular stocks and trade on the basis of that information tend to bias their interpretation of subsequent information in the direction of their original view. This produces autocorrelations and patterns of price movement that can predict future prices, such as the “head-and-shoulders” and “double-top” patterns. The model also predicts that sequential price jumps for a particular stock will be positively autocorrelated. We test this prediction and find that jumps exhibit statistically and economically significant positive autocorrelations. Understanding the way in which psychological bias impacts asset prices will benefit portfolio managers and may help to mitigate its effects on market efficiency.

Publication Information
Article Title: Price Trends and Patterns in Technical Analysis: A Theoretical and Empirical Examination
Journal: Journal of Banking and Finance (2009)
Author(s): Friesen, Geoffrey C;  Weller, Paul A.;  Dunham, Lee M.
Researcher Information
    
Friesen, Geoffrey C
Friesen, Geoffrey C
Associate Professor of Finance
Expertise:
  • Behavioral Finance
  • Financial Institutions
  • Financial Markets & Investing
  • Insurance
Finance
CoB 425 N
P.O. Box 880490
University of Nebraska-Lincoln
Lincoln, NE 68588-0490, USA
Phone: (402) 472-2334
Fax: (402) 472-5140
gfriesen2@unl.edu