Technical Trading with Imperfect Competition

Abstract

Technical analysis (TA) is modeled as a method to infer market liquidity demand.An informed trader and a number of uninformed technical traders employ TA and trade strategically with liquidity traders and risk-averse market makers. Price change is positively related to both order flow and accumulated order flow in the presence of technical traders. Technical trading (i.e., trading based on TA) of the informed trader and technical traders tends to offset the previous order imbalance (similar to asynchronized trading in Grossman and Miller, 1988), and generates negative return autocorrelations. As the number of technical traders increases, price impact declines and price informativeness improves, but successive return autocovariances and autocorrelations become more negative.