3.1 Technical analysis

Technical analysis assumes that there are patterns in market prices, e.g. in exchange rates, that will recur in the future and that these patterns can be used for predictive purposes.

This means that technical analysis directly contradicts the hypothesis of efficient markets. In other words, technical analysts, or chartists, use the past history of, for example, the exchange rate to detect patterns which they extrapolate into the future utilizing technical trading rules.

These trading rules are heuristic forecasting methods which chartists claim give them an edge in forecasting the movements of market prices, e.g. the movements of exchange rates.

Papers that present evidence that there is predictive power contained in some of the trading rules used by chartists are Brock et al. (1992), Gencay (1996b), LeBaron (1996), Levich and Thomas (1993), Sweeney (1986) and Taylor (1992). Specifically, it appears that the predictive ability is greatest for the foreign exchange markets and, of interest from a practical point of view, that the magnitude of trading profitability makes up for the costs of trading in these markets.

It thus seems that Michael Jensen, the founding editor of Journal of Financial Economics, was too hasty when he stated that "... there is no other proposition in economics which has more solid empirical evidence supporting it than the Efficient Market Hypothesis" (Jensen, 1978).

Prof. Mikael Bask