Methodical madness: Technical analysis and the irrationality of exchange-rate forecasts

dSubstantial empirical research documents that exchange-rate forecasts are: not formed rationally. This paper identifies a common technical trading signal, the head-and-shoulders pattern, as a potential source of departures from rationality in exchange-rate forecasts. Forecasts based on this pattern are evaluated for daily dollar exchange rates over 1973 to 1994, using two criteria for rationality: profitability and efficiency. Resulting profits,, replicable in real-time, are tested for statistical significance using a bootstrap technique. We find that the rule is profitable, but not efficient, since it is dominated by simpler trading rules.