Handbook of Exchange Rates

12.6 Conclusion

Technical analysis is a popular and widely used approach to trading in the foreign exchange market. Survey evidence shows that it dominates fundamental analysis at short horizons. These findings were first established for traders in the London market but have subsequently been confirmed to hold in other markets. Researchers have demonstrated that TTRs were able to generate excess returns over a long period during the 1970s and 1980s. The excess returns to relatively simple rules based on filters or MAs had disappeared by the early 1990s, but returns to more complex or sophisticated rules have persisted.

We have considered several hypotheses that the literature has advanced to explain these observations. We are able with some confidence to rule out data mining as an explanation for the early profitability of technical rules. Both out-of-sample analysis and adjustments to statistical tests indicate that the returns were genuine. Another possible explanation centers on the intervention operations of the central bank. If the central bank has a target for the exchange rate that differs from its fundamental value, then intervention may allow speculators to profit at the expense of the bank. In particular, if the central bank adopts a strategy of “leaning against the wind,” then this may create predictable trends in the exchange rate that can be detected by technical analysis. However, research using high frequency data has shown that the periods of the greatest profitability ...