Testing the Effect of Technical Analysis on Market Quality and Order Book Dynamics

Abstract

We find empirical support for the theoretical finding in agent-based models of limit order book markets that the effect of technical trading on market quality is not positive. When signals occur, technical traders lower liquidity as proxied by the relative spread, the effective spread, the realized spread, the dispersion and the slope in the order book. Technical trading is also found to be accompanied by rising volatility. There is overall strong empirical support against the hypothesis that technical trading has no effect on order book dynamics.

Keywords: Agent-based model, Liquidity, Technical Analysis, Limit Order Market

JEL Classification: G14, D82, C5