The suspension of disbelief: the myth of market memories

Jiang, Lan (2009) The suspension of disbelief: the myth of market memories. Doctoral thesis, London Metropolitan University.

Abstract

Although the Efficient Market Hypothesis dismisses the idea that markets have a memory, technical chartists continue to believe that markets can react in similar ways to similar past events. One of the methods of technical analysis commonly used is candlestick charting. The objective of this thesis is to investigate whether or not candlestick charting can be used to predict stock market price movements. This research is in both a quantitative and qualitative form and seeks to establish whether the signals released by candlestick charting could have helped investors to earn abnormal returns over the 25 year period from 1984 to 2008. The FTSE 100 index has been chosen to represent the UK stock market as a whole. The month of May has been chosen because in this month the stock market exhibits a high volatility. The quantitative analysis is based on the use of a statistical correlation analysis which is applied both to particular candlesticks and to candlestick patterns. Interviews have also been conducted with financial professionals to gain a qualitative insight into their attitudes towards candlestick charting. A literature review is included to provide a comprehensive overview of the relevant literature in order to develop an understanding of previous work in the field of stock market performance prediction theories. The research suggests that candlesticks and candlestick patterns are not correlated with the movements of share prices, and therefore cannot be used to earn abnormal returns. Candlestick charting can only show stock market reversals and can provide early turning signals. Candlesticks appear to be popular as a result of their "magical" properties in helping investors overcome their fears of the market. This research adds significantly to the understanding of the limitations of technical market analysis and also lends support to the Efficient Market Hypothesis.

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