Skip to main content

A New Anomaly: The Cross-Sectional Profitability of Technical Analysis

  • Yufeng Han (a1), Ke Yang (a2) and Guofu Zhou (a3)

In this paper, we document that an application of a moving average timing strategy of technical analysis to portfolios sorted by volatility generates investment timing portfolios that substantially outperform the buy-and-hold strategy. For high-volatility portfolios, the abnormal returns, relative to the capital asset pricing model (CAPM) and the Fama-French 3-factor models, are of great economic significance, and are greater than those from the well-known momentum strategy. Moreover, they cannot be explained by market timing ability, investor sentiment, default, and liquidity risks. Similar results also hold if the portfolios are sorted based on other proxies of information uncertainty.

Hide All
Ang, A., and Bekaert, G.. “Stock Return Predictability: Is It There?Review of Financial Studies, 20 (2007), 651707.
Ang, A.; Hodrick, R. J.; Xing, Y.; and Zhang, X.. “The Cross-Section of Volatility and Expected Returns.” Journal of Finance, 61 (2006), 259299.
Asparouhova, E.; Bessembinder, H.; and Kalcheva, I.. “Noisy Prices and Inference Regarding Returns.” Journal of Finance, 68 (2013), 665714.
Avramov, D.; Chordia, T.; Jostova, G.; and Philipov, A.. “Dispersion in Analysts’ Earnings Forecasts and Credit Rating.” Journal of Financial Economics, 91 (2009), 83101.
Baker, M. P., and Wurgler, J.. “Investor Sentiment and the Cross-Section of Stock Returns.” Journal of Finance, 61 (2006), 16451680.
Baker, M. P., and Wurgler, J.. “Investor Sentiment in the Stock Market.” Journal of Economic Perspectives, 21 (2007), 129151.
Balduzzi, P., and Lynch, A. W.. “Transaction Costs and Predictability: Some Utility Cost Calculations.” Journal of Financial Economics, 52 (1999), 4778.
Barberis, N.; Shleifer, A.; and Vishny, R.. “A Model of Investor Sentiment.” Journal of Financial Economics, 49 (1998), 307343.
Berkman, H.; Dimitrov, V.; Jain, P. C.; Koch, P. D.; and Tice, S.. “Sell on the News: Differences of Opinion, Short-Sales Constraints, and Returns around Earnings Announcements.” Journal of Financial Economics, 92 (2009), 376399.
Bharath, S. T., and Shumway, T.. “Forecasting Default with the Merton Distance to Default Model.” Review of Financial Studies, 21 (2008), 13391369.
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.
Campbell, J. Y., and Thompson, S. B.. “Predicting Excess Stock Returns Out of Sample: Can Anything Beat the Historical Average?Review of Financial Studies, 21 (2008), 15091531.
Cespa, G., and Vives, X.. “Dynamic Trading and Asset Prices: Keynes vs. Hayek.” Review of Economic Studies, 79 (2012), 539580.
Chabot, B. R.; Ghysels, E.; and Jagannathan, R.. “Momentum Cycles and Limits to Arbitrage: Evidence from Victorian England and Post-Depression U.S. Stock Markets.” Working Paper, University of North Carolina-Chapel Hill and Northwestern University (2010).
Chincarini, L. B., and Kim, D.. Quantitative Equity Portfolio Management: An Active Approach to Portfolio Construction and Management. New York, NY: McGraw-Hill (2006).
Chordia, T., and Shivakumar, L.. “Momentum, Business Cycle, and Time-Varying Expected Returns.” Journal of Finance, 57 (2002), 9851019.
Cochrane, J. H. “The Dog That Did Not Bark: A Defense of Return Predictability.” Review of Financial Studies, 21 (2008), 15331575.
Collin-Dufresne, P.; Goldstein, R. S.; and Martin, J. S.. “The Determinants of Credit Spread Changes.” Journal of Finance, 56 (2001), 21772207.
Cooper, M. J.; Gutierrez, R. C. Jr.; and Hameed, A. S.. “Market States and Momentum.” Journal of Finance, 59 (2004), 13451365.
Covel, M. W. Trend Following: How Great Traders Make Millions in Up or Down Markets. New York, NY: Prentice-Hall (2005).
Cowles, A. “Can Stock Market Forecasters Forecast?Econometrica, 1 (1933), 309324.
Daniel, K.; Hirshleifer, D.; and Subrahmanyam, A.. “Investor Psychology and Security Market Under- and Overreactions.” Journal of Finance, 53 (1998), 18391885.
Diether, K. B.; Malloy, C. J.; and Scherbina, A.. “Differences of Opinion and the Cross Section of Stock Returns.” Journal of Finance, 57 (2002), 21132141.
Ericsson, J.; Jacobs, K.; and Oviedo, R.. “The Determinants of Credit Default Swap Premia.” Journal of Financial and Quantitative Analysis, 44 (2009), 109132.
Faber, M. T. “A Quantitative Approach to Tactical Asset Allocation.” Journal of Wealth Management, 9 (2007), 6979.
Fama, E. F., and French, K. R.. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, 33 (1993), 356.
Fama, E. F., and Schwert, W.. “Asset Returns and Inflation.” Journal of Financial Economics, 5 (1977), 115146.
Ferson, W. E., and Harvey, C. R.. “The Variation of Economic Risk Premiums.” Journal of Political Economy, 99 (1991), 385415.
Ferson, W. E., and Schadt, R. W.. “Measuring Fund Strategy and Performance in Changing Economic Conditions.” Journal of Finance, 51 (1996), 425461.
Fung, W., and Hsieh, D. A.. “The Risk in Hedge Fund Strategies: Theory and Evidence from Trend Followers.” Review of Financial Studies, 14 (2001), 313341.
Gehrig, T., and Menkhoff, L.. “Extended Evidence on the Use of Technical Analysis in Foreign Exchange.” International Journal of Finance and Economics, 11 (2006), 327338.
Goh, J.; Jiang, F.; Tu, J.; and Zhou, G.. “Forecasting Government Bond Risk Premia Using Technical Indicators.” Working Paper, Singapore Management University and Washington University in St. Louis (2013).
Goldman, M. B.; Sosin, H. B., and Gatto, M. A.. “Path Dependent Options: ‘Buy at the Low, Sell at the High.’Journal of Finance, 34 (1979), 11111127.
Griffin, J. M.; Ji, X.; and Martin, J.. “Momentum Investing and Business Cycle Risk: Evidence from Pole to Pole.” Journal of Finance, 58 (2003), 25152547.
Han, Y. “Asset Allocation with a High Dimensional Latent Factor Stochastic Volatility Model.” Review of Financial Studies, 19 (2006), 237271.
Han, Y., and Lesmond, D. A.. “Liquidity Biases and the Pricing of Cross-Sectional Idiosyncratic Volatility.” Review of Financial Studies, 24 (2011), 15901629.
Han, Y.; Wang, X.; Zhou, G.; and Zou, H.. “Are There Trends in Chinese Stock Market?” Working Paper, University of Colorado Denver and Washington University in St. Louis (2013).
Han, Y., and Zhou, G.. “Trend Factor: A New Determinant of Cross-Section Stock Returns.” Working Paper, University of Colorado Denver and Washington University in St. Louis (2013a).
Han, Y., and Zhou, G.. “Twin Momentums in the Stock Market.” Working Paper, University ofColorado Denver and Washington University in St. Louis (2013b).
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.
Hjalmarsson, E. “Predicting Global Stock Returns.” Journal of Financial and Quantitative Analysis, 45 (2010), 4980.
Hong, H., and Stein, J. C.. “A Unified Theory of Underreaction, Momentum Trading, and Overreaction in Asset Markets.” Journal of Finance, 54 (1999), 21432184.
Huang, D.Market States and International Momentum Strategies.” Quarterly Review of Economics and Finance, 46 (2006), 437446.
Jegadeesh, N., and Titman, S.. “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency.” Journal of Finance, 48 (1993), 6591.
LeBaron, B.Technical Trading Rule Profitability and Foreign Exchange Intervention.” Journal of International Economics, 49 (1999), 125143.
Leland, H. E., and Toft, K. B.. “Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads.” Journal of Finance, 51 (1996), 9871019.
Lo, A. W., and Hasanhodzic, J.. The Heretics of Finance: Conversations with Leading Practitioners of Technical Analysis. New York, NY: Bloomberg Press (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.
Longstaff, F. A., and Schwartz, E. S.. “A Simple Approach to Valuing Risky Fixed and Floating Rate Debt.” Journal of Finance, 50 (1995), 789819.
Lynch, A. W., and Balduzzi, P.. “Predictability and Transaction Costs: The Impact on Rebalancing Rules and Behavior.” Journal of Finance, 66 (2000), 22852309.
Merton, R. C. “On the Pricing of Corporate Debt: The Risk Structure of Interest Rates.” Journal of Finance, 29 (1974), 449470.
Merton, R. C.On Market Timing and Investment Performance. I. An Equilibrium Theory of Value for Market Forecasts.” Journal of Business, 54 (1981), 363406.
Neely, C. J. “The Temporal Pattern of Trading Rule Returns and Central Bank Intervention: Intervention Does Not Generate Technical Trading Rule Profits.” Working Paper, Federal Reserve Bank of St. Louis (2002).
Neely, C. J.; Rapach, D. E.; Tu, J.; and Zhou, G.. “Forecasting the Equity Risk Premium: The Role of Technical Indicators.” Management Science, forthcoming (2013).
Newey, W. K., and West, K. D.. “A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix.” Econometrica, 55 (1987), 703708.
Pástor, L., and Stambaugh, R. F.. “Liquidity Risk and Expected Stock Returns.” Journal of Political Economy, 111 (2003), 642685.
Rapach, D. E.; Strauss, J. K.; and Zhou, G.. “Out-of-Sample Equity Premium Prediction: Combination Forecasts and Links to the Real Economy.” Review of Financial Studies, 23 (2010), 821862.
Rapach, D. E.; Strauss, J. K.; and Zhou, G.. “International Stock Return Predictability: What Is the Role of the United States?Journal of Finance, 68 (2013), 16331662.
Schwager, J. D. Market Wizards: Interviews with Top Traders. New York, NY: Collins (1993).
Schwert, G. W.Anomalies and Market Efficiency.” In Handbook of the Economics of Finance, Vol. 1, Constantinides, G. M., Harris, M., and Stulz, R. M., eds. Amsterdam, Netherlands: Elsevier (2003), 939974.
Spiegel, M., and Wang, X.. “Cross-Sectional Variation in Stock Returns: Liquidity and Idiosyncratic Risk.” Working Paper, Yale University (2005).
Stambaugh, R. F.; Yu, J.; and Yuan, Y.. “The Short of It: Investor Sentiment and Anomalies.” Journal of Financial Economics, 104 (2012), 288302.
Stoll, H. R. “The Pricing of Security Dealer Services: An Empirical Study of Nasdaq Stocks.” Journal of Finance, 33 (1978), 11531172.
Treynor, J. L., and Mazuy, K.. “Can Mutual Funds Outguess the Market?Harvard Business Review, 44 (1966), 131136.
Wilcox, C., and Crittenden, E.. “Does Trend Following Work on Stocks?” Working Paper, Blackstar Funds, LLC (2009).
Zhang, X. F.Information Uncertainty and Stock Returns.” Journal of Finance, 61 (2006), 105137.
Zhou, G., and Zhu, Y.. “An Equilibrium Model of Moving-Average Predictability and Time-Series Momentum.” Working Paper, Tsinghua University and Washington University in St. Louis (2013).
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: 0 *
Loading metrics...

Abstract views

Total abstract views: 0 *
Loading metrics...

* Views captured on Cambridge Core between <date>. This data will be updated every 24 hours.

Usage data cannot currently be displayed