Technical Analysis, Liquidity, and Price Discovery
54 Pages Posted: 5 Jun 2016 Last revised: 17 Dec 2016
Date Written: October 12, 2016
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: Suggested Citation