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Profiting from a contrarian application of technical trading rules in the US stock market

Abstract

The variance ratio test suggests that we cannot reject the random walk null hypothesis for three major US stock market indexes between 1990 and 2007. Moreover, we find that the naïve forecasting model based on the random walk assumption frequently generates more accurate forecasts than those generated by the autoregressive integrated moving average forecasting model. Consistent with this finding, we find that the regular application of three commonly used technical trading rules (the moving average crossover rule, the channel breakout rule and the Bollinger band breakout rule) underperform the buy-and-hold strategy between 1990 and 2007. However, we observe significant positive returns on trades generated by the contrarian version of these three technical trading rules, even after considering a 0.5 per cent transaction costs on all trades.

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Notes

  1. 1.

    These test statistics of forecasting efficiency are defined by Greene (2000) as follows:

    where P*=forecast price, P=actual price, T=number of forecast horizons.

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Correspondence to Nauzer Balsara.

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Balsara, N., Chen, J. & Zheng, L. Profiting from a contrarian application of technical trading rules in the US stock market. J Asset Manag 10, 97–123 (2009). https://doi.org/10.1057/jam.2008.44

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Keywords

  • random walk
  • forecasting stock prices
  • technical trading rules
  • contrarian trading