ProzacMarket 21casionally expressed the fear that the interrelationships of stoc kprice
changes are so complex that standard tools like these cannot reveal
them. That fear led to efforts to dispute the model by designing
trading rules that could achieve above-normal returns by uncovering
and exploiting these greater complexities.
Among the most primitive though most illustrative trading rules
was Sidney Alexander’s “filter technique.” This is a strategy designed
to discern and exploit assumed trends in stoc kprices that, in Alex-
ander’s piquant phrase, may be “masked by the jiggling of the mar-
ket.”^4
For instance, a “5% filter rule” for a stoc kwould say to buy it
when the price goes up 5% (and watch it rise to a higher peak); then
sell it when the price goes down 5% from that pea k(and watch it
fall to a lower trough); then short the stoc k(i.e., borrow it and sell
it at the prevailing price, promising to repay with the same stock, to
be purchased for the price prevailing at the time of repayment); then,
when the price rises 5% from that trough, cover the short position.
If this works, you get a gain on the initial sale plus a gain on the
short position. More important, if it works, prices are following a
peak-trough pattern. That means they are not random and the ran-
dom wal kmodel is contradicted.
Alexander’s initial results indicated that such a technique could
produce above-normal returns. Subsequent refinements of Alexan-
der’s wor kby himself and others, including Fama, however, dem-
onstrated that relaxing or changing certain assumptions eliminated
the abnormal returns, particularly the original filter technique’s fail-
ure to note that dividends are a cost rather than a benefit when
stocks are sold short.
Alexander’s filter technique epitomizes the chartist or technical
approach to stoc kanalysis and trading, under which a study of past
prices (or other data) is used as a basis for predicting future prices.
Indeed, Alexander’s filter technique is a conceptual cousin of limit
orders and similar techniques prevalent in securities trading today.
These techniques include conventional technical methods that rely
on anomaly effects (the insider, month, weekend, and analyst ef-
fects) as well as the more unconventional methods (the hemline
indicator, the Super Bowl indicator, and so on).
These and related philosophies such as “momentum investing”
and “sector rotation” remain staples of Wall Street futurology. They
are widely and increasingly used by traders and recommended by
investment advisers and brokers. They are nonsense, as many stu-