Handbook of Finance: Investment Management and Financial Management

Chapter 34. A Support Level for Technical Analysis

ROBERT A. SCHWARTZ, PhD

Marvin M. Speiser Professor of Finance and University Distinguished Professor, Zicklin School of Business, Baruch College, CUNY

RETO FRANCIONI, PhD

Chief Executive Officer, Deutsche Börse

BRUCE W. WEBER, PhD

Professor of Information Management, London Business School

Abstract: Technical analysis involves extracting useful trading information from market data (recent transaction prices, share volumes) to predict future price changes and to market time trades. A closely associated procedure, computer-driven algorithmic trading, is used to achieve executions in automated markets with the aim of controlling trading costs and taking advantage of short-lived trading opportunities. Technical analysis has long been used by practitioners and, in recent years, algorithmic trading has risen rapidly to the fore. Neither procedure would have validity, however, in an environment where markets are informationally efficient and prices follow random walks. Yet they may have important roles to play in markets that are characterized by trading frictions (spreads, market impact, and other transaction costs), imperfect price discovery, and incomplete quantity discovery.

Keywords: technical analysis, charting, algorithmic trading, random walk, efficient markets hypothesis, price discovery, quantity discovery, trading costs, divergent expectations, adaptive valuations, multiple equilibria, path dependency, support and resistance levels, ...