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Handbook of Exchange Rates by Lucio Sarno, Ian Marsh, Jessica James

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12.3 Studies of Technical Analysis in the Foreign Exchange Market

12.3.1 Why Study Technical Analysis?

The widespread use of technical analysis in foreign exchange (and other) markets is puzzling because it implies that either traders are irrationally making decisions on useless information or that past prices contain useful information for trading. The latter possibility would contradict the “efficient markets hypothesis,” which holds that no trading strategy should be able to generate unusual profits on publicly available information—such as past prices—except by bearing unusual risk, and the observed level of risk-adjusted profitability measures market (in)efficiency. Therefore, much research effort has been directed toward determining whether technical analysis is indeed profitable or not. One of the earliest studies, by Fama and Blume (1966), found no evidence that a particular class of TTRs could earn abnormal profits in the stock market. However, more recent research by Brock et al. (1992) and Sullivan et al. (1999) has provided contrary evidence. And many studies of the foreign exchange market have found evidence that TTRs can generate persistent profits (Dooley and Shafer, 1984; Gençay, 1999; Lee et al., 2001; Levich and Thomas, 1993; Neely et al., 1997; Poole, 1967; Sweeney, 1986; Martin, 2001).

12.3.2 Survey Evidence on the Practice of Technical Analysis

An important area of research on technical analysis has focused on documenting how and to what extent it is actually ...

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