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Chasing trends at the micro-level: The effect of technical trading on order book dynamics

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  • Chiarella, Carl
  • Ladley, Daniel

Abstract

Technical traders attempt to exploit trends in market prices and the order flow. Despite this little is known about how these traders behave in a micro-structure context. We consider a model of an order book based financial market. The market contains two groups: informed traders and technical traders. A numerical technique is used to identify a Markov perfect equilibrium of the trading game and so determine the optimal strategies. We find that technical trading rules are profitable and allow traders to increase their returns. The effect of technical traders on the market, however, is ambiguous. They decrease volatility and pricing errors but also increase trading costs despite primarily acting as liquidity suppliers.

Suggested Citation

  • Chiarella, Carl & Ladley, Daniel, 2016. "Chasing trends at the micro-level: The effect of technical trading on order book dynamics," Journal of Banking & Finance, Elsevier, vol. 72(S), pages 119-131.
    • Handle: RePEc:eee:jbfina:v:72:y:2016:i:s:p:s119-s131
    DOI: 10.1016/j.jbankfin.2015.11.019
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    Cited by:

    1. Jackson, Antony & Ladley, Daniel, 2016. "Market ecologies: The effect of information on the interaction and profitability of technical trading strategies," International Review of Financial Analysis, Elsevier, vol. 47(C), pages 270-280.
    2. Bernales, Alejandro & Ladley, Daniel & Litos, Evangelos & Valenzuela, Marcela, 2021. "Dark trading and alternative execution priority rules," LSE Research Online Documents on Economics 118866, London School of Economics and Political Science, LSE Library.
    3. Schmitt, Noemi & Westerhoff, Frank, 2021. "Trend followers, contrarians and fundamentalists: Explaining the dynamics of financial markets," Journal of Economic Behavior & Organization, Elsevier, vol. 192(C), pages 117-136.
    4. Ladley, Daniel, 2020. "The high frequency trade off between speed and sophistication," Journal of Economic Dynamics and Control, Elsevier, vol. 116(C).
    5. Paolo Mazza & Mikael Petitjean, 2019. "Testing the effect of technical analysis on market quality and order book dynamics," Applied Economics, Taylor & Francis Journals, vol. 51(18), pages 1947-1976, April.
    6. Daniel Ladley, 2019. "The Design and Regulation of High Frequency Traders," Discussion Papers in Economics 19/02, Division of Economics, School of Business, University of Leicester.

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    More about this item

    Keywords

    Market micro-structure; Technical trading; Order book; Market efficiency; Dynamic equilibrium;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques

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