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Technical Trends: Can they be used to earn abnormal profits?

Technical Trends: Can they be used to earn abnormal profits?. Ryan Weikert. Last Time. MACD E(profit) ≈ ½ (mu)(S 0 ) SD ≈ 2/3 (sigma)(S 0 ) RSI – Quick Trigger E(profit) ≈ 0 CCI – Quick Trigger E(profit) ≈ 0.

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Technical Trends: Can they be used to earn abnormal profits?

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  1. Technical Trends: Can they be used to earn abnormal profits? Ryan Weikert

  2. Last Time • MACD • E(profit) ≈ ½ (mu)(S0) • SD ≈ 2/3 (sigma)(S0) • RSI – Quick Trigger • E(profit) ≈ 0 • CCI – Quick Trigger • E(profit) ≈ 0

  3. Technical Indicators applied to random walks generated using Geometric Brownian Motion will not yield abnormal returns

  4. New Studies • More realistic distribution • Lévy Processes • Autoregressive Models (AR & ARMA) • Correlation between price movements and technical indicators

  5. Historical Returns Daily Return

  6. Stable Distribution • rstable(alpha,beta,gamma,mu) • Alpha=parameter • Beta=skewness • Gamma=scale • Mu=shift

  7. Change Model • Old Model • Walk[j]=walk[j-1]*(1+mu*dt+rnorm(nruns,0,s*sqrt(dt)) • New Model • walk[j]=walk[j=1]*(1+rstable(1.9,0,s*sqrt(dt)/2,mu*dt))

  8. MACD with new Model • Standard deviation of closing prices increases ever so slightly while mean remained constant • Expected profit and standard deviation generated by MACD signals remain unchanged • Slight improvement

  9. Lévy Processes: Definition • Starts at some origin at time t=0 • Independent Increments • Stationary Increments • Right continuous with left limits • Geometric Brownian Motion is a Lévy Process

  10. Lévy Processes • Randomize mu • Randomize sigma • Sigma mean reversion

  11. Autoregressive Models • Use previous outputs to predict the next output • Output=Constant+Parameters+randomness(white noise) • AutoRegressive Conditional Heteroskedasticity (ARCH) Models – variance is a function of previous period’s variance

  12. AR Results • E(profit) = 13.85 stderr=.0035 • MACD E(profit)=6.46 stderr=.00234 • Same as before

  13. Correlation between MACD signals and subsequent price changes

  14. S&P 500 Returns after MACD signal For 1 Year Period Beginning N Years ago Days after Signal

  15. Results for S&P 500 • Long Position • E(profit) = 111.78 • Stderr=2.212 • MACD Trading • E(profit)=0.28 • Stderr=1.897

  16. Can Technical Trends be used to generate abnormal returns?

  17. No Abnormal Returns • Efficient Markets • Independent increments • Lévy Processes • Various Distributions • In reality, day to day prices are not correlated • Indicators are lagging • Returns following a MACD signal are not correlated to the signal

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