Multiscale Analysis of Foreign Exchange Order Flows and Technical Trading Profitability

Abstract

This paper investigates the multiscale (frequency-dependent) relationship between technical trading profitability and feedback trading effects in the Canada/U.S. dollar foreign exchange market. The results suggest weak evidence that technical trading activities of financial and non-financial customers drive frequent violations of the FX market microstructure assumption that exchange rate movements are driven by order flow. After controlling for transaction costs, we find that the contribution of financial customers in feedback trading dominates the contribution of non-financial customers at lower frequencies, while the opposite holds at higher frequencies. In addition, the novel finding is that technical indicators constructed from order flows can be profitable.

Keywords: Foreign Exchange Markets, Order Flows, Technical Trading, Frequency Domain

JEL Classification: F31, G14, C53