Technical Analysis, Liquidity, and Price Discovery

54 Pages Posted: 5 Jun 2016 Last revised: 17 Dec 2016

See all articles by Felix Fritz

Felix Fritz

Karlsruhe Institute of Technology

Christof Weinhardt

Karlsruhe Institute of Technology

Date Written: October 12, 2016

Abstract

Academic literature suggests that Technical Analysis (TA) plays a role in the decision making process of some investors. If TA traders act as uninformed noise traders and generate a relevant amount of trading volume, market quality could be affected. We analyze moving average (MA) trading signals as well as support and resistance levels with respect to market quality and price efficiency. For German large-cap stocks we find excess liquidity demand around MA signals and high limit order supply on support and resistance levels. Depending on signal type, spreads increase or remain unaffected which contradicts the mitigating effect of uninformed TA trading on adverse selection risks. The analysis of transitory and permanent price components demonstrates increasing pricing errors around TA signals, while for MA permanent price changes tend to increase of a larger magnitude. This suggests that liquidity demand in direction of the signal leads to persistent price deviations.

Keywords: Technical Analysis, Market Microstructure, Noise Trading, Liquidity

JEL Classification: G12, G14

Suggested Citation

Fritz, Felix and Weinhardt, Christof, Technical Analysis, Liquidity, and Price Discovery (October 12, 2016). Paris December 2016 Finance Meeting EUROFIDAI - AFFI, Available at SSRN: https://ssrn.com/abstract=2788997 or http://dx.doi.org/10.2139/ssrn.2788997

Felix Fritz (Contact Author)

Karlsruhe Institute of Technology ( email )

Kaiserstraße 12
Karlsruhe, Baden Württemberg 76131
Germany

Christof Weinhardt

Karlsruhe Institute of Technology ( email )

Kaiserstraße 12
Karlsruhe, Baden Württemberg 76131
Germany

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