pletely eliminated. In fact, an earlier study by Werner De Bondt and
Richard Thaler found that stocks that performed poorly over the previ-
ous three- to five-year period significantly outperformed, over the next
three to five years, those stocks that had done well, implying a mean re-
version of longer-run stock returns.^16
The success of momentum investing cannot be explained within an
efficient-market framework. It appears that investors underreact to
short-term information, which causes the stock to continue to move in
the same direction over time rather than adjusting instantaneously. Un-
fortunately momentum investing does not guarantee success: recent ev-
idence suggests that while professional investors achieve excess returns
with a momentum strategy, individual investors tend to underperform
the market. This may be because individual investors often focus on the
very best performing stocks, which tend to become overpriced quickly
and suffer poor returns, while those well-performing stocks that do not
make it to the very top of the list and are bought by professionals tend to
have the best momentum returns.^17CONCLUSION
Proponents of technical analysis claim it helps investors identify the
major trends of the market and when those trends might reverse. Yet
there is considerable debate about whether such trends exist, or whether
they are just runs of good and bad returns that are the result of random
price movements.
Burton Malkiel has been quite clear in his denunciation of technical
analysis. In his bestselling work A Random Walk Down Wall Street, he pro-
claims:Technical rules have been tested exhaustively by using stock price data on
both major exchanges, going back as far as the beginning of the 20th cen-
tury. 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 in-
vestors who follow its precepts will accomplish nothing but increasing
substantially the brokerage charges they pay.^18CHAPTER 17 Technical Analysis and Investing with the Trend 303
(^16) Werner F. M. De Bondt and Richard Thaler, “Does the Stock Market Overreact?” Journal of Finance,
vol. 40, no. 3 (July 1985), pp. 793–805.
(^17) Glenn N. Pettengill, Susan M. Edwards, and Dennis E. Schmitt, “Is Momentum Investing a Viable
Strategy for Individual Investors?” Financial Services Review, vol. 15, no. 3 (2006), pp. 181–197.
(^18) Burton Malkiel, A Random Walk Down Wall Street, New York: Norton, 1990, p. 133.