Investment Strategies Based on Technical Indicators: Evidence of Investor Behavioural Reactions

Abstract

Effectiveness and efficiency of investment is related to the use of technical analysis tools to maximize returns and minimize trading risks as the two challenges researchers commonly face. In the present study, the daily stock price information of 135 companies listed on Tehran Stock Exchange (TSE) during the period of 2010-2020 was used to investigate their investment strategies based on technical indicators in both short-term and medium-term periods. Investor behavioral reactions were indicated by the utilized technical indicators. The relationship between the values of the technical indicators and stock returns showed that the signals represented by the three indicators of Moving Average (MA), Exponential Moving Average (EMA), and Relative Strength Index (RSI) over a weekly to 6-month period to buy or sell the stocks (as a strategy) performed better than the other indicators. Therefore, investors can use a combination of these three indicators to determine their strategies of buying and selling so as to obtain more returns.IntroductionBehavioral finance is one of the new topics that has been raised and considered by some financial researchers over the past few decades. The behavioral financial perspective states that most investors’ behaviors depend on judgment, emotional tendency, and informal sources of information. A significant number of studies has shown that investors’ emotional behaviors affect the stock market. According to the traditional view of stock returns, changes in the stock price are related to systematic changes in the firm’s core values. However, recent studies have shown that investor’s emotional tendency plays an important role in setting prices and determining time-series returns. The effectiveness and efficiency of technical analysis tools can be determined by their applications to maximize returns and minimize transaction risks as the challenges researchers frequently face. There are several strategies for stock trading in a financial markets. Most of these strategies are based on some technical indicators. This study examined the performance of 11 technical indicators to find which ones better represent the investors’ behavioral reactions and finally provide an optimal investment strategy by combining them. Method and DataTo investigate the relationship between the values of the technical indicators and stock returns, we extracted the daily stock price data of 135 companies listed in Tehran Stock Exchange (TSE) during the period of 2010-2020 and accordingly used the regression method and panel data. FindingsThe values of investments in the weekly to 6-month modes showed that the 6-month information led to higher returns compared to the weekly information, indicating significantly increased returns represented by the 11 studied indicators with the increasing time of the period. The indicators of Moving Average (MA), Exponential Moving Average (EMA), and Relative Strength Index (RSI) had the highest return values ​​in both the weekly and monthly information modes. In the mode of 6-month data, the true strength index (TSI) had a lower coefficient of variation, but better performance than the other indicators. Among the 11 indicators studied, the indicators of MA and EMA had a higher coefficient with stock returns in the short- and medium-term investments. The higher coefficient meant that the returns were enhanced by increasing these indicators of buying and selling. Therefore, they had more power or strength than the other indicators and could better represent the stock returns. The relationship between the values of the technical indicators and returns in the short run revealed that the indicator of MA better represented the stock returns compared to the other indicators. In the medium term, the mentioned indicator was a better indicator for representing the stock returns. When comparing performance of the strategies by the use of the technical indicators, moving from a weekly to 6-month period demonstrated more returns related to the mentioned indicators that were significantly different from the returns represented by the other indicators. Conclusion and discussion In all the investment periods, the indicator of MA had more power to influence on the returns and better represented the stock returns as compared to the other indicators. The signals that were given by the three indicators of MA, EMA, and RSI in the different short and medium-term periods to buy or sell the stocks (as a strategy) better showed the investors’ behavioral reactions and could be thus utilized with higher confidence in comparison to the other indicators since leading to higher returns and profitability. As the trend of the returns represented by the mentioned indicators moved from weekly to the 6-month mode, a larger difference was achieved in terms of significance, indicating that the relationship between the values of the technical indicators and stock returns could provide better buying-selling signals in a longer period.

Keywords

• investment strategy
• technical indicator
• behavioral reaction
• risk and return
• performance