The Role of Technical Analysis in Retail Investor Trading

Abstract

Technical Analysis (TA) is a security analysis methodology based on the study of past market data. Although it has been criticized by academics and the profitability of many related strategies has been statistically rejected, TA remains highly popular among practitioners and retail investors, in particular. We analyze the role of TA for retail investors trading structured products (knock-outs and warrants) on Stuttgart Stock Exchange. We find a 35% increase in trading activity on days of chart pattern trading signals and an 11% increase for moving average signals. The increase in activity typically reverses on the following trading days. Furthermore, we identify trading characteristics of round-trip trades and find that trades associated with TA trading signals differ. First, we find significantly higher raw returns in TA-related trades while leverage levels at purchase as well as holding duration appear to be lower. Second, the shape of the realized return distribution of trades in accordance to TA signals is distinct from their peer groups. Specifically, realized returns are significantly less left-skewed (more right-skewed). In this regard, retail investors using TA methods might be less prone to the disposition effect due to the system-based trading approach. If we assume a general gambling intention with respect to the considered products, then TA-related trades tend to reach this goal more effectively.