Chapter 1 Introduction

As long as financial markets have existed, people have tried to forecast them, in the hope that good forecasts would bring them great fortunes. In financial practice it is not the question whether it is possible to forecast, but how the future path of a financial time series can be forecasted. In academia, however, it is merely the question whether series of speculative prices can be forecasted than the question how to forecast. Therefore practice and academics have proceeded along different paths in studying financial time series data. For example, among practitioners fundamental and technical analysis are techniques developed in financial practice according to which guidelines financial time series should and could be forecasted. They are intended to give advice on what and when to buy or sell. In contrast, academics focus on the behavior and characteristics of a financial time series itself and try to explore whether there is certain dependence in successive price changes that could profitably be exploited by various kinds of trading techniques. However, early statistical studies concluded that successive price changes are independent. These empirical findings combined with the theory of Paul Samuelson, published in his influential paper ``Proof that Properly Anticipated Prices Fluctuate Randomly'' (1965), led to the efficient markets hypothesis (EMH). According to this hypothesis it is not possible to exploit any information set to predict future price changes. In another influential paper Eugene Fama (1970) reviewed the theoretical and empirical literature on the EMH to that date and concluded that the evidence in support of the EMH was very extensive, and that contradictory evidence was sparse. Since then the EMH is the central paradigm in financial economics.

Technical analysis has been a popular and heavily used technique for decades already in financial practice. It has grown to an industry on its own. During the 1990s there was a renewed interest in academia on the topic when it seemed that early studies which found technical analysis to be useless might have been premature. In this thesis a large