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Stock prices are the first types of publicly available financial information and technical analysis uses past financial data to predict future prices and their trends. Technical analysis has become an interesting field among academics and chartists since the publication of Efficient Market Hypothesis (EMH) by Fama (1970). According to EMH, in an efficient market, stock price reflects fully all the available information and rational investors make better price discovery. Hence no strategy will give higher than simple buy-and-hold return in an efficient market. On the other hand, authors like Irwin and Park (2007) and Lento (2008) substantiated technical analysis and reported excess returns over simple buy-and-hold policy by applying technical rules.
The efficacy of technical analysis was tested by many academicians and technical analysts. Alexander (1961) tested his popular filter trading rules and found significant increase in stock returns when the filter was applied in mechanical trading. However, when transaction cost was taken into consideration, the same was found to be insignificant by Fama and Blume (1966). Sweeney (1988) found that filter rules, applied to 15 of the 30 Dow Jones stocks, earned excess returns over buy-and-hold return (for more details, see Russell and Torbey, 2002).
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