The impact of informed trading on the effectiveness of technical indicators: A behavioral finance perspective

Abstract

This paper introduces a novel approach that bridges the efficacy of technical indicators with the realm of informed trading, positing that the strategic manipulation of these indicators is the linchpin linking the two domains. By developing and utilizing the Proportion of Contrarian (PC) Trades indicator, rooted in behavioral finance principles, and its enhanced counterpart, the Proportion of Contrarian Trades-New (PCN) indicator, this study offers innovative measures of informed trading. Employing a multivariate regression model, the study explores the impact of these indicators on the continuity and profitability of moving average technical indicators. The findings significantly advance the understanding of how informed trading, particularly through large contrarian trades, reduces the continuity of technical signals, thereby increasing short-term market volatility. Furthermore, the study provides robust evidence of how informed traders may manipulate technical indicators to generate misleading signals, which has profound implications for the accuracy of technical analysis. By introducing these innovative indicators and proposing a novel lens through which to view the confluence of technical analysis and informed trading, the study brings a new viewpoint to traditional analytical methods and provides valuable insights to both market participants and regulatory bodies.