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11. Contingency and Markets > The Fleeting Profitability of Mechanical Trading ...

THE FLEETING PROFITABILITY OF
MECHANICAL TRADING RULES

As with estimated relationships between asset prices and fundamentals, contingent change implies that any fully prespecified trading rule that generates above-average returns over some past stretch of time, after accounting for risk, will eventually cease to do so. This implication goes a long way toward resolving one of the core “puzzles” in financial economics.

Early studies of the performance of trading rules that extrapolate past price trends found little evidence that they delivered any profits at all (for a review, see Fama, 1970). However, more recent studies, which have looked at a much wider array of technical rules and trading horizons, claim that rules based on intraday horizons do generate above-average returns after accounting for risk.9Economists have also estimated fixed-parameter models of asset returns and report apparently stable patterns in the data that could be used to earn above-average returns after accounting for risk.


  

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