Sentiment and Technical Analysis

Abstract

This paper studies the effectiveness of technical trading approaches in market environments of varying sentiment. Due to short-sale constraints, overpricing with high sentiment (i.e. relatively optimistic sentiment) is more prevalent compared to underpricing with low sentiment (i.e. relatively pessimistic sentiment) and this effect is stronger on difficult-to-arbitrage securities. The authors find consistent evidence over the period of 1993-2010 that the examined set of technical indicators perform better during periods of high sentiment than during periods of low sentiment. Moreover, this sentiment effect is relatively more pronounced for small stocks. These findings hold after a number of robustness checks are applied and highlight the importance of incorporating the sentiment effect when using technical indicators.