Is There Momentum in the Stock Market?

Is There Momentum in the Stock Market?

The technician believes that knowledge of a stock’s past behavior can help predict its probable future behavior. In other words, the sequels of price changes prior to any given day is important in predicting the price change for that day. This might be called the wallpaper principle. The technical analyst tries to predict future stock prices just as we might predict that the pattern above the mirror. The basic premise is that there are repeatable patterns in space and time.

Chartists believe there is momentum in the market. Supposedly, stocks that have been rising will continue to do so, and those that begin falling will go on sinking. Should the stock begin to fall or “act poorly,” investors are advised to sell.

These technical rules have been tested exhaustively by using stock price data on both major exchanges going back as far as the beginning of the twentieth century. The results reveal conclusively that past movements in stock prices cannot be used to foretell future movements. The stock market has no memory. The central proposition of charting is absolutely false, and investors who follow its precepts will accomplish nothing but increasing substantially the brokerage charges they pay.

The City of Toronto has established many park`s facilities over the past years, including Hillside Gardens, three swimming pools, tennis courts, field houses and an outdoor ice rink. Sakura, Sunday. Photo by Elena

One set of tests, perhaps the simplest of all, compares the price change for a stock in a given period with the price change in a subsequent period. For example, technical lore hast it that if the price of a stock rose yesterday it is more likely to rise today. It turns out that the correlation of past price movements with present and future price movements is close to zero. Las week’s price change bears little relationship to the price change this week, and so forth. Whatever slight dependencies have been found between stock price movements in different time periods are so small that individuals who pay commission costs cannot hope to profit from them.

Economists have also examined the technician’s thesis that there are often sequences of price change in the same direction over several days (or several weeks of months). Stocks are likened to fullbacks who, once having gained some momentum, can be expected to carry on for a long gain. It turns out that this is simply not the case. Sometimes one gets positive price changes (rising prices) for several days in a row; but sometimes when you are flipping a fair coin you also get a long string of “heads” in a row, and you get sequences of positive (or negative) price changes no more frequently than you can expect random sequences of heads or tails in a row. What are often called “persistent patterns” in the stock market occur no more frequently than the runs of luck in the fortunes of any gambler playing a game of chance. This is what the economist means when he says that stock prices behave like a random walk.

Burton G. Malkiel. A Random Walk Down Wall Street, including a life-cycle guide to personal investing. First edition, 1973, by W.W. Norton and company, Inc