INTERVIEW
A Tech In The Fed
Carol Osler
by John Sweeney
Hidden away in the Federal Reserve System are entire departments
of economists researching nearly every aspect of US business. In late 2000,
we picked up hints of an economist who had actually taken on the definition
and measurement of the concepts of technical analysis. Some sleuthing brought
up Carol Osler's name.
Osler is a senior economist in the Capital Markets Research Function
of the Federal Reserve Bank of New York. Her major interest is in explaining
short-run exchange rate movements. In particular, she has focused on technical
trading strategies, largely because they are used so widely in the market
even though they fail to fit standard academic models. She has also researched
banking, corporate finance, equity prices, and the influence of speculative
bubbles on real investment.
Osler received her bachelor's degree from Swarthmore College and
her doctorate from Princeton University. Prior to joining the New York
Fed, she taught at the Amos Tuck School of Business at Dartmouth College
and the Kellogg School of Management at Northwestern University. After
coming to New York, she also taught in the Columbia University Economics
Department for a number of years.
STOCKS & COMMODITIES Interim Editor John Sweeney caught up with
Osler on March 19, 2001, to explore her work in quantifying some of technical
trading's hoariest maxims: support and resistance levels. And there was
more.
ILLUSTRATION BY CARL GREEN
First of all, I don't know much about you, since
Federal Reserve people aren't usually prominent publicly. Can you give
us a description of your work?
Sure. My research primarily focuses on the exchange rate movements on
a daily or intraday basis, and I'm interested in whether technical analysis
works and, if it does, why.
How did you get into the technical analysis side of this?
Honestly, I backed into it. I initially thought that technical analysis
was probably just craziness in the market. And I wanted to make the point
that such craziness was there and that it mattered for prices. But when
I tested the stuff, I found it was not crazy. It worked. So I'm now making
a career of showing that it actually works and why.
I remember you started off with a study of head-and-shoulders patterns.
Can you describe that study?
I looked at whether head-and-shoulders patterns are useful for predicting
exchange rate movements, using daily exchange rates over about 20 years.
The study, "Methodical Madness: The Head-And-Shoulders Pattern In
Foreign Exchange," was written jointly with Kevin Chang. We found
that head-and-shoulders patterns were pretty useful for forecasting exchange
rate movements. But when we looked at it more closely, we found that you
could actually do a lot better using much simpler technical tools, such
as moving averages or filter rules. The head-and-shoulders strategy overlapped
strongly with the others in terms of the positions they recommended, but
the simpler technical rules were more frequently right. So we argued that
the head-and-shoulders strategy, while potentially useful if there was
nothing else available, was what we refer to as dominated by the much simpler
rules.
In the abstract of another paper, you reported that head-and-shoulders
trading is generally unprofitable.
Yes. In that paper, titled "Identifying Noise Traders: The Head-And-Shoulders
Pattern in US Equities," I looked at the stock market and came to
a very different conclusion about the usefulness of the head-and-shoulders
pattern. I looked at daily stock prices for 100 different firms, which
I chose at random. First of all, I asked: Are head-and-shoulders patterns
profitable in the stock market? I found that on average, they absolutely
are not.
So then I wondered whether there was active trading on this pattern
that does not seem to be profitable in the equities markets. I was able
to show statistically that there's a lot of extra trading volume right
around the time my analysis says people should be taking positions. And
the extra trading volume peaks on the exact day I think people should be
taking positions, and then it tapers off over the next few days, just as
I would have expected. So it sure looks like people are trading on head-and-shoulders
patterns, but on average they are not getting much out of it in equities
markets.
What do you suppose is the difference in the markets here? Stocks
versus foreign exchange?
That's a really good question. A lot of people in the market think it
might be a self-fulfilling prophecy; the more technical trading there is,
the more it makes profitable patterns, so the more that people trade on
it. It's my impression that there is more technical trading in the foreign
exchange market, so it could be self-fulfilling. Somehow, I think there
has to be more going on.
The foreign exchange market does tend to be dominated by institutional
traders - a smaller number, say, 3,000?5,000 of them, versus the equity
markets, which might be affected by a larger number of individuals. Could
that be important?
It's hard to know why it would matter whether it was the trading of
institutions versus the trading of individuals. I have identified one factor
that differs between stock and FX markets that might help explain why technical
analysis works better in FX - stop-loss orders are used very heavily in
the FX market, but fairly infrequently in stock markets. This could matter
because, as I show in another paper, stop-loss orders have a lot to do
with the success of some standard technical strategies in the FX market.
...Continued in the June 2001 issue of Technical Analysis of STOCKS
& COMMODITIES
The views expressed herein are not necessarily those of the Federal
Reserve System or the Federal Reserve Bank of New York.
Excerpted from an article originally published
in the June 2001 issue of Technical Analysis of STOCKS & COMMODITIES
magazine. All rights reserved. © Copyright 2001, Technical Analysis,
Inc.
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