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Updated: December 26, 2010 15:24 IST

Look for robust market signals

D. Murali
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Any analytical approach to financial market forecasting, be it fundamental or technical analysis, will have to confront the prospect of losing its effectiveness after becoming public knowledge, writes Xin Xie in ‘Full View Integrated Technical Analysis: A systematic approach to active stock market investing’ (www.wiley.com).

By offering mostly robust signals, FVITA can have a good chance of surviving such a damning prospect, he adds. The abbreviation is the book’s title; and the system proposed by the author aims to take all trends of different durations into consideration, and to incorporate information about different aspects of the market dynamics from multiple indicators.

‘Technical’ flaws

In the preface, Xin notes that the current approaches to technical analysis are far from satisfactory. First, it fails too often; and the explanatory power of any given individual indicator is too low and resulting uncertainty is too high, he frets. “Skills accumulated over many years of experience may help to reduce the uncertainty and increase the success rate. But this suggests that a crucial part of the knowledge remains tacit and cannot be easily passed on to other people.”

More importantly, as the author cautions, when indicators fail to offer the right signal, there is no good explanation, and therefore one is condemned to repeat the mistake the next time around.

Market is volatile and fractal

Xin acknowledges that there is a rich set of indicators and an abundance of different approaches to technical analysis offering different perspectives on market dynamics, which can potentially be used together to provide significantly better understanding about market movements. He rues, however, that in reality not much effort has been directed at exploring the joint explanatory power and the collective wisdom of this diverse set of accumulated knowledge.

The integrated system discussed in the book is based on the analysis of different time intervals according to market conditions, considering two fundamental facts about the stock market. These are: One, the stock market is volatile (‘a deeper and longer trend needs a deeper and longer countermovement to confirm its reversal and differentiate it from movement caused by volatility’); and two, the stock market is fractal (‘the structure of the stock market, and the financial market in general, is the same across different time intervals’).

Surviving public exposure

Towards the close of the book is a section on technical analysis as public knowledge, where the author takes up the common fear that technical rules cannot survive public exposure. And that market dynamics will be affected as more and more people know about a particular technical trading rule; because front running may occur, making the rule ineffective one way or the other.

Xin assures that there are two cases in which technical rules can survive the transition from private information to public knowledge. First, ‘the profit will persist as long as the second indicator or the way to use the two indicators jointly remains private information,’ as explained through an example in the book. And, second, if the original indicator being used is robust with a success rate of close to 100 per cent, then the publication of such a rule will not reduce its effectiveness because market behaviour around the point where the rule may be applied will not be changed, the author observes.

To those who swear by statistical analysis, Xin’s recommendation is to avoid using data series of relatively short history. “With data that has a long history, subgroup consistency of the specified relationship must be examined. The data should be divided into several subgroups to check whether the statistical relationship can be consistently estimated over each sub-period with significant and stable parameter values.”

For the serious investment analysts.

**

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