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A View on Technical Indicators and Trading Systems

Introduction

Technical indicators seek to predict the direction and magnitude of future price changes for stocks or other instruments.
Rarely, however, do we ever see a books on technical analysis show whether those technical stock indicators have predictive value over a broad range of stocks over a long period of time. That is not for lack of well known statistical techniques, but rather, we believe, because the results of such analyses would be less than impressive in a wide array of cases and, as we will show below, would contradict many of the precepts of technical analysis. Similarly, maxims like "the trend is your friend" suggest that stocks that are currently in an identifiable uptrend are more likely to continue that uptrend rather than reverse. Although there are ways to formalize and test such statements, it is rarely done in the publications where the expression is used, except for the occasional provision of well-selected examples. For examples that do involve rigorous testing, see academic finance articles on momentum trading strategies.

In this multi-part article, we describe some common technical indicators and their traditional interpretations. We describe a scoring system based on the interpretations of those traditional technical indicators, and also a scoring system based on statistical analysis using the same indicators. We demonstrate the predictive ability of each of the two systems, and how the two are related. These two scoring systems are highlighted in the Weekly Technical Status Report. Specifically, we show how well each does in predicting price changes 20 days forward for 100 stocks over 1,000 days of market data. We then present, test, and discuss 15 different trading systems. We draw several conclusions about technical indicators and trading systems from these results.


Continue to part 2 - "Common Technical Indicators and Interpretations"

Contents: A View on Technical Indicators and Trading Systems