Stock market trading rule based on pattern recognition and technical analysis: Forecasting the DJIA index with intraday data

• This work provides empirical evidence which confronts the Efficient Market Hypothesis.
• This work introduces a new definition of the flag pattern.
• The results show that the trading rule can beat the market.
• The European market is more inefficient than the US market.

This work presents empirical evidence which confronts the classical Efficient Market Hypothesis, which states that it is not possible to beat the market by developing a strategy based on a historical price series.We propose a risk-adjusted profitable trading rule based on technical analysis and the use of a new definition of the flag pattern. This rule defines when to buy or sell, the profit pursued in each operation, and the maximum bearable loss. In order to untie the results from randomness, we used a database comprised of 91,307 intraday observations from the US Dow Jones index. We parameterized the trading rule by generating 96 different configurations and reported the results of the whole sample over 3 subperiods. In order to widen its validity we also replicated the analysis on two leading European indexes: the German DAX and the British FTSE. The returns provided by the proposed trading rule are higher for the European than for the US index, which highlights the greater inefficiency of the European markets.