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The Predictive Power of Stock Market Indicators

Published online by Cambridge University Press:  19 October 2009

Ben Branch
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Extract

Empirical research has cast so much doubt on chart readers that most capital theorists have about as much faith in charts as astronomers have in astrology. Certainly there is overwhelming evidence that attempting to predict future price changes on the basis of past price behavior is unproductive. There is, however, another aspect of technical analysis which has received much less attention from academicians. In its narrow form technical analysis seeks to forecast the direction of price movements of individual securities from past price and volume data. A second and somewhat broader type of technical analysis concentrates on the prediction of general market movements and trends relying on a broader set of information. Various market indicators are said to offer signals useful in forecasting future prices. One type seeks to measure investor sentiment through what might be called mood variables. A second type of indicator is more closely related to fundamental factors affecting future supply and demand for securities. Both types of indicators, however, are designed to be used in predicting future market movements rather than the movements of individual stock prices. This is to be contrasted with fundamental analysis which is concerned with predicting future prices of individual securities by analyzing the underlying factors related to the firm's future profitability. Most of the prior work with market indicators takes one or another proposed market indicator and examines the historical relation, between the indicator and some market index such as the Dow Jones Industrial Average.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 11 , Issue 2 , June 1976 , pp. 269 - 285
Copyright
Copyright © School of Business Administration, University of Washington 1976

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References

1 There is one minor exception to this statement. In some earlier work the premium and discount on closed-end mutual funds was tested on a somewhat different data set than employed here. Because it worked poorly and data were difficult to obtain, it was dropped from the list of independent variables in this study. For discussion of this index see, Zweig, M., “An Investor Expectation Stock Rise Prediction Model Using Closed-End Premiums,” Journal of Finance (March 1973), pp. 67–78CrossRefGoogle Scholar.

2 Mayor, T., “Short Trading Activity and the Price of Equities: Some Simulative and Regressive Results,” Journal of Financial and Quantitative Analysis (September 1968), pp. 283–298CrossRefGoogle Scholar. and Smith, R., “Short Interest and Stock Market Prices,” Financial Analysts Journal (November–December 1968), pp. 151–154CrossRefGoogle Scholar.

3 McDonald, J. and Baron, D., “Risk and Return on Short Position on Common Stocks,” Journal of Finance (March 1973), pp. 97–107CrossRefGoogle Scholar.

4 Raihall, D. and Jepson, J., “The Application of Odd Lot Buy Signals to Dividend Stocks,” Mississippi Valley Journal of Business and Economics (Winter 1972–1973)., p. 19–30Google Scholar. Gup, B., “A Note on Stock Market Indicators and Pricing,” Journal of Financial and Quantitative Analysis (September 1973), pp. 673–682CrossRefGoogle Scholar. and Zweig, M., “Stalking the Bear: A New Odd Lot Indicator Has Just Turned Bullish,” Barrons (July 23, 1973), p. 11Google Scholar.

5 Zweig, M., “Uncanny Floor Traders,” Barron's (April 22, 1974), p. 11Google Scholar.

6 Ring, J., “Confidence Index, It Works Better at Tops than at Bottoms,” Barron's (March 25, 1974), p. 11Google Scholar.

7 Kent, W., The Smart Money (Garden City, N.Y.: Doubleday, 1972)Google Scholar.

8 Merjos, A., “Few Big Sellers; The Dearth of Secondary Distributions Is Bullish,” Barron's (October 15, 1973), p. 5Google Scholar.

9 Gup, “Note on Stock Market Indicators.”

10 Sprinkel, B., Money and Markets: A Monetarist's Vice, Homewood, Ill.: (Irwin 1971)Google Scholar; Homa, K. and Jaffee, D., “The Supply of Money and Common Stock Price,” Journal of Finance (December 1971), pp. 1045–1066CrossRefGoogle Scholar. Two other studies reached the same conclusion as H., & Hamberger, J. M., and Kochin, L., “Money and Stock Prices: The Channels of Influence,” Journal of Finance (May 1972), p. 231, 249Google Scholar; Malkiel, B. and Quandt, R., “Selected Economic Indicators and Forecasts of Stock Prices,” Research Memorandum #9, Finance Resource Center, Princeton University (1971)Google Scholar. Using both Canadian and U.S. data Pesando reached similar conclusions as M & Q. See Pesando, J., “The Supply of Money and Common Stock Prices: Further Observations on the Econometric Evidence.” Working Paper #7215, Institute for the Quantitative Analysis of Social and Economic Policy, University of Toronto, Toronto, Canada (November 1972)Google Scholar. Malkiel and Quandt tone down the thrust of their point in: Melkiel, B. and Quandt, R., “The Supply of Money and Common Stock Prices: Comment,” Journal of Finance (September 1972), pp. 921–926CrossRefGoogle Scholar. and Rudolph, J., “The Money Supply and Common Stock Prices,” Financial Analyst Journal (March/APril 1972), pp. 19–25CrossRefGoogle Scholar. Cooper, R., “Efficient Capital Markets and the Quantity Theory of Money,” Journal of Finance (June 1974), pp. 887–908CrossRefGoogle Scholar.

11 Alchian, A. and Kessel, R., “Redistribution of Wealth through Inflation,” Science, vol. 130, no. 3375 (September 4, 1959), p. 538CrossRefGoogle ScholarPubMed; Reilly, F. K., Johnson, G. L., and Smith, R. E., “Inflation, Inflation Hedge, and Common Stocks,” Financial Analysts Journal, vol. 28 (January–February 1970), pp. 104–110CrossRefGoogle Scholar. Keran, M. W., “Expectations, Money, and the Stock Market,” unpublished (Saint Louis: Federal Reserve Bank of Saint Louis, January 1971), pp. 16–31Google Scholar. Oudet, B., “The Variation of the Return in Periods of Inflation,” Journal of Financial and Quantitative Analysis, vol. 8 (March 1973), pp. 247–258CrossRefGoogle Scholar. Brinson, G. P., “The Synergistic Impact of Taxes and Inflation on Investment Return,” Financial Analysts Journal, vol. 30 (March–April 1973), pp. 74–75CrossRefGoogle Scholar. Branch, Ben, “Common Stock Performance and Inflation: An International Comparison,” Journal of Political Economy (January 1974), pp. 48–52Google Scholar.

12 Zweig, “Investor Expectation Stock Rise Prediction Model.”

13 Zweig, M., “Fed Indicator,” Barton's (January 20, 1975), p. 11Google Scholar.

14 Turov, D., “Buy Signal? A New Technical Indicator Is Flashing One,” Barton's (December 9, 1974), p. 11Google Scholar.

15 Gup is an exception here though he only examined three indicators simultaneously.

16 In August 1964 the NYSE changed the rules making floor trading much more restrictive. The most important change required that floor trades must be stabilizing; that is, purchase must occur when the stock is declining or sales when the stock is rising. For this reason the floor trade data pre-August 1964 must be handled differently from later data.

17 Refer to sources in footnote 10.