Skip to main content

Sentiment and the Effectiveness of Technical Analysis: Evidence from the Hedge Fund Industry


This article presents a unique test of the effectiveness of technical analysis in different sentiment environments by focusing on its usage by perhaps the most sophisticated and astute investors, namely, hedge fund managers. We document that during high-sentiment periods, hedge funds using technical analysis exhibit higher performance, lower risk, and superior market-timing ability than nonusers. The advantages of using technical analysis disappear or even reverse in low-sentiment periods. Our findings are consistent with the view that technical analysis is relatively more useful in high-sentiment periods with larger mispricing, which cannot be fully exploited by arbitrage activities because of short-sale impediments.

Corresponding author
* Smith,, Y. Wang (corresponding author),, School of Business and Center for Institutional Investment Management, State University of New York at Albany; N. Wang (corresponding author),, and Zychowicz,, Zarb School of Business, Hofstra University.
Hide All
Ackermann C.; McEnally R.; and Ravenscraft D.. “The Performance of Hedge Funds: Risk, Return, and Incentives.” Journal of Finance, 54 (1999), 833874.
Agarwal V.; Boyson N. M.; and Naik N. Y.. “Hedge Funds for Retail Investors? An Examination of Hedged Mutual Funds.” Journal of Financial and Quantitative Analysis, 44 (2009), 273305.
Agarwal V.; Daniel N. D.; and Naik N. Y.. “Role of Managerial Incentives and Discretion in Hedge Fund Performance.” Journal of Finance, 64 (2009), 22212256.
Aggarwal R. K., and Jorion P.. “The Performance of Emerging Hedge Funds and Managers.” Journal of Financial Economics, 96 (2010), 238256.
Antoniou C.; Doukas J. A.; and Subrahmanyam A.. “Cognitive Dissonance, Sentiment, and Momentum.” Journal of Financial and Quantitative Analysis, 48 (2013), 245275.
Aragon G. O.Share Restrictions and Asset Pricing: Evidence from the Hedge Fund Industry.” Journal of Financial Economics, 83 (2007), 3358.
Baker M., and Wurgler J.. “Investor Sentiment and the Cross-Section of Stock Returns.” Journal of Finance, 61 (2006), 16451680.
Bessembinder H., and Chan K.. “The Profitability of Technical Trading Rules in the Asian Stock Markets.” Pacific-Basin Finance Journal, 3 (1995), 257284.
Bessembinder H., and Chan K.. “Market Efficiency and the Returns to Technical Analysis.” Financial Management, 27 (1998), 517.
Blume L.; Easley D.; and O’Hara M.. “Market Statistics and Technical Analysis: The Role of Volume.” Journal of Finance, 49 (1994), 153181.
Brock W.; Lakonishok J.; and LeBaron B.. “Simple Technical Trading Rules and the Stochastic Properties of Stock Returns.” Journal of Finance, 47 (1992), 17311764.
Brown D. P., and Jennings R. H.. “On Technical Analysis.” Review of Financial Studies, 2 (1989), 527551.
Brown S. J.; Fraser T. L.; and Liang B.. “Hedge Fund Due Diligence: A Source of Alpha in a Hedge Fund Portfolio Strategy.” Journal of Investment Management, 6 (2008), 2333.
Brown S. J.; Goetzmann W. N.; and Park J.. “Careers and Survival: Competition and Risks in the Hedge Fund and CTA Industry.” Journal of Finance, 56 (2001), 18691886.
Brunnermeier M. K., and Nagel S.. “Hedge Funds and the Technology Bubble.” Journal of Finance, 59 (2004), 20132040.
Busse J. A.Volatility Timing in Mutual Funds: Evidence from Daily Returns.” Review of Financial Studies, 12 (1999), 10091041.
Cao C.; Chen Y.; Liang B.; and Lo A. W.. “Can Hedge Funds Time Market Liquidity?Journal of Financial Economics, 109 (2013), 493516.
Cao C.; Simin T. T.; and Wang Y.. “Do Mutual Fund Managers Time Market Liquidity?Journal of Financial Markets, 16 (2013), 279307.
Carhart M. M.On Persistence in Mutual Fund Performance.” Journal of Finance, 52 (1997), 5782.
Chen Y.Derivatives Use and Risk Taking: Evidence from the Hedge Fund Industry.” Journal of Financial and Quantitative Analysis, 46 (2011), 10731106.
Chen Y.; Han B.; and Pan J.. “Noise Trader Risk and Hedge Fund Returns.” Working Paper, Texas A&M University, University of Toronto, and University of Utah (2014).
Chen Y., and Liang B.. “Do Market Timing Hedge Funds Time the Market?Journal of Financial and Quantitative Analysis, 42 (2007), 827856.
Covel M. W. Trend Following: How Great Traders Make Millions in Up or Down Markets. Upper Saddle River, NJ: Prentice Hall (2005).
Da Z.; Engelberg J.; and Gao P.. “The Sum of All Fears: Investor Sentiment and Asset Prices.” Working Paper, University of Notre Dame and University of California at San Diego (2013).
De Long J. B.; Shleifer A.; Summers L. H.; and Waldmann R. J.. “Noise Trader Risk in Financial Markets.” Journal of Political Economy, 98 (1990), 703738.
Fama E. F.The Behavior of Stock-Market Prices.” Journal of Business, 38 (1965), 34105.
Fung W., and Hsieh D. A.. “Empirical Characteristics of Dynamic Trading Strategies: The Case of Hedge Funds.” Review of Financial Studies, 10 (1997), 275302.
Fung W., and Hsieh D. A.. “Hedge Fund Benchmarks: A Risk-Based Approach.” Financial Analysts Journal, 60 (2004), 6581.
Getmansky M.; Lo A. W.; and Makarov I.. “An Econometric Model of Serial Correlation and Illiquidity in Hedge Fund Returns.” Journal of Financial Economics, 74 (2004), 529610.
Griffin J. M.; Harris J. R.; Shu T.; and Topaloglu S.. “Who Drove and Burst the Tech Bubble?Journal of Finance, 66 (2011), 12511290.
Grundy B. D., and McNichols M.. “Trade and the Revelation of Information through Prices and Direct Disclosure.” Review of Financial Studies, 2 (1989), 495526.
Han Y.; Yang K.; and Zhou G.. “A New Anomaly: The Cross-Sectional Profitability of Technical Analysis.” Journal of Financial and Quantitative Analysis, 48 (2013), 14331461.
Henriksson R. D., and Merton R. C.. “On Market Timing and Investment Performance II: Statistical Procedures for Evaluating Forecasting Skills.” Journal of Business, 54 (1981), 513533.
Hong H., and Stein J. C.. “A Unified Theory of Underreaction, Momentum Trading and Overreaction in Asset Markets.” Journal of Finance, 54 (1999), 21432184.
Kavajecz K. A., and Odders-White E. R.. “Technical Analysis and Liquidity Provision.” Review of Financial Studies, 17 (2004), 10431071.
Liang B.Hedge Funds: The Living and the Dead.” Journal of Financial & Quantitative Analysis, 35 (2000), 309326.
Liang B.The Accuracy of Hedge Fund Returns.” Journal of Portfolio Management, 29 (2003), 111122.
Lo A. W.Where Do Alphas Come from? A Measure of Active Investment Management.” Journal of Investment Management, 6 (2008), 129.
Lo A. W., and Hasanhodzic J.. The Heretics of Finance: Conversations with Leading Practitioners of Technical Analysis. New York: John Wiley & Sons (2009).
Lo A. W.; Mamaysky H.; and Wang J.. “Foundations of Technical Analysis: Computational Algorithms, Statistical Inference, and Empirical Implementation.” Journal of Finance, 55 (2000), 17051770.
Menkhoff L., and Taylor M. P.. “The Obstinate Passion of Foreign Exchange Professionals: Technical Analysis.” Journal of Economic Literature, 45 (2007), 936972.
Miller E. M.Risk, Uncertainty, and Divergence of Opinion.” Journal of Finance, 32 (1977), 11511168.
Neely C. J.; Rapach D. E.; Tu J.; and Zhou G.. “Forecasting the Equity Risk Premium: The Role of Technical Indicators.” Management Science, 60 (2014), 17721791.
Neely C.; Weller P.; and Dittmar R.. “Is Technical Analysis in the Foreign Exchange Market Profitable? A Genetic Programming Approach.” Journal of Financial and Quantitative Analysis, 32 (1997), 405426.
Park C.-H., and Irwin S. H.. “What Do We Know about the Profitability of Technical Analysis?Journal of Economic Surveys, 21 (2007), 786826.
Schwager J. D. The New Market Wizards: Conversations with America’s Top Traders. New York: John Wiley & Sons (1995).
Shen J., and Yu J.. “Investor Sentiment and Economic Forces.” Working Paper, University of Minnesota (2014).
Shleifer A., and Summers L. H.. “The Noise Trader Approach to Finance.” Journal of Economic Perspectives, 4 (1990), 1933.
Stambaugh R. F.; Yu J.; and Yuan Y.. “The Short of It: Investor Sentiment and Anomalies.” Journal of Financial Economics, 104 (2012), 288302.
Stambaugh R. F.; Yu J.; and Yuan Y.. “Arbitrage Asymmetry and the Idiosyncratic Volatility Puzzle.” Journal of Finance, 70 (2015), 19031948.
Teo M.The Geography of Hedge Funds.” Review of Financial Studies, 22 (2009), 35313561.
Treynor J. L., and Ferguson R.. “In Defense of Technical Analysis.” Journal of Finance, 40 (1985), 757773.
Treynor J. L., and Mazuy K.. “Can Mutual Funds Outguess the Market?Harvard Business Review, 44 (1966), 131136.
White H.A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity.” Econometrica, 48 (1980), 817838.
Yu J.A Sentiment-Based Explanation of the Forward Premium Puzzle.” Journal of Monetary Economics, 60 (2013), 474491.
Yu J., and Yuan Y.. “Investor Sentiment and the Mean-Variance Relation.” Journal of Financial Economics, 100 (2011), 367381.
Zhu Y., and Zhou G.. “Technical Analysis: An Asset Allocation Perspective on the Use of Moving Averages.” Journal of Financial Economics, 92 (2009), 519544.
Recommend this journal

Email your librarian or administrator to recommend adding this journal to your organisation's collection.

Journal of Financial and Quantitative Analysis
  • ISSN: 0022-1090
  • EISSN: 1756-6916
  • URL: /core/journals/journal-of-financial-and-quantitative-analysis
Please enter your name
Please enter a valid email address
Who would you like to send this to? *


Altmetric attention score

Full text views

Total number of HTML views: 0
Total number of PDF views: 251 *
Loading metrics...

Abstract views

Total abstract views: 856 *
Loading metrics...

* Views captured on Cambridge Core between 29th December 2016 - 23rd November 2017. This data will be updated every 24 hours.