Technical Indicator Model of Stock Returns

Do models of the cross-section of future stock returns based on technical indicators work as well as those based on fundamental factors? In their December 2021 paper entitled “Technical Indicators and Cross-Sectional Expected Returns”, Hui Zeng, Ben Marshall, Nhut Nguyen and Nuttawat Visaltanachoti investigate the combined abilities of 14 technical indicators to explain differences in next-month returns across stocks. These indicators involve trend-following for various lookback intervals up to 12 months based on: (1) crossover of short and long price moving averages, (2) price momentum and (3) on-balance volume. The authors apply a smoothed ordinary least squares method, which averages regression coefficients over time, to combine the technical indicators. They compare the predictive power of this 14-indicator model to that of the widely used Fama-French 3-factor (market, size, book-to-market) model of stock returns. They further measure returns to a hedge portfolio that is each month long (short) the equal-weighted or value-weighted tenth, or decile, of stocks with the highest (lowest) expected returns based on the 14-indicator model. The methodology allows calculation of initial model returns starting January 1932 for the full sample period and for three equal subperiods. Using monthly data for all listed U.S. stocks during January 1926 through December 2020 (excluding delisted firms) and contemporaneous conventional factor returns as available through December 2020, they find that:

(more…)