Technical Analysis and Mutual Funds. Testing Trading Rules

Topics: Stock market, Technical analysis, Investment Pages: 13 (3465 words) Published: June 22, 2008
ABSTRACT: This paper attempts to develop strategies that enable portfolio managers to improve market timing by learning to recognize leading indications of forthcoming changes. The aim of this study is the testing, in a Mutual Fund series, of the predicting ability of a popular technical exchange tool, the Moving Average Rule. A short-term and a long-term moving average are used for the creation of “buy” and “sell” signals of mutual funds. 2891 predictions were made, for the same time-series, for different values of short-term and long-term moving averages and the profitability of this method was calculated. The method was proved profitable, if no buy and sell cost was counted. The Two Moving Average Rule by itself is efficient only for the companies that administrate the respective mutual fund and not for the single investor. It is presented the triple moving average rule, which possibly can be a solution for this problem. KEYWORDS: Technical Analysis, Mutual Funds, Moving Average Rule, Decision Making INTRODUCTION

The decision-making process could break down into two separate stages-analysis and timing. Because of the high leverage factor in the future markets, timing is especially crucial to successful trading. It is quite possible to be correct on the general trend of the market and still lose money. Because margin requirements are so low in future trading, a relatively small price move in the wrong direction can force the trader out of the market with the resulting loss of all or most of that margin. In stock market trading, by contrast, a trader who finds him or herself on the wrong side of the market can simply decide to hold onto the stock, hoping that it will stage a comeback at some point in the future. This is how many traders stop being traders and become investors.

Technical analysts attempt to forecast prices by the study of past prices and a few other related summary statistics about security trading. They believe that shifts in supply and demand can be detected in charts of market action. Technical analysis is considered by many to be the original form of investment analysis, dating back to the 1800s. (Brock- Lakonishok – Baron 1992)

Chartist, or Technical analysis of financial markets involves providing forecasts of asset prices or trading advice on the basis of visual examination of the past history of price movements (Edwards and Magee, 1967). Perhaps with the aid of certain quantitative summary measures of past price movements such as ‘momentum’ indicators (‘oscillators’) or moving averages (Murphy, 1986), but without regard to any underlying economic, or ‘fundamental’ analysis. Technical analysis is the study of market action, primarily through the use of charts, for the purpose of forecasting future price trends. The term "market action" includes the three principal sources of information available to the technician-price, volume, and open interest. The term "price action", which is often used, seems too narrow because most commodity technicians include volume and open interest as an integral part of their market analysis. With this distinction made, the terms "price action" and "market action" are used interchangeably throughout the remainder of this discussion.

A question often asked is whether technical analysis as applied to commodity futures is the same as the stock market. The answer is both yes and no. The basic principles are the same, but there are some significant differences. The principles of technical analysis were first applied to stock market forecasting and only later adapted to commodities. Most of the basic tools-bar charts point and figure charts, price patterns, volume, trendlines, moving averages, and oscillators, for example-are used in both areas. Anyone who has learned these concepts in either stocks or commodities wouldn't have too much trouble making the adjustment to the other side. However, there are some general areas of difference having more to do with the different,...
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