This paper documents clustering in currency stop-loss and take-pro¢t orders, and uses that clustering to provide an explanation for two familiar predictions from technical analysis: (1) trends tend to reverse course at predictable support and resistance levels, and (2) trends tend to be unusually rapid after rates cross such levels. The data are the ¢rst available on individual currency stop-loss and take-pro¢t orders. Take-pro¢t orders cluster particularly strongly at round numbers, which could explain the ¢rst prediction. Stop-loss orders cluster strongly just beyond round numbers, which could explain the second prediction.

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Substantial empirical research documents that exchange-rate forecasts are not formed rationally. This paper identi®es a common technical trading signal, the head-and-shoulders pattern, as a potential source of departures from rationality in exchange-rate forecasts. Forecasts based on this pattern are evaluated for daily dollar exchange rates over 1973 to 1994, using two criteria for rationality: pro®tability and ef®ciency. Resulting pro®ts, replicable in real-time, are tested for statistical signi®cance using a bootstrap technique. We ®nd that the rule is pro®table, but not ef®cient, since it is dominated by simpler trading rules.

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may AbstractThis paper makes three contributions to our understanding of the price discovery process in currency markets. First, it provides evidence that this process cannot be the familiar one based on adverse selection and customer spreads, since such spreads are inversely related to a trade's likely information content. Second, the paper suggests three potential sources for the pattern of customer spreads, two of which rely on the information structure of the market. Third, the paper suggests an alternative price discovery process for currencies, centered on inventory management strategies in the interdealer market, and provides preliminary evidence for that process. PRICE DISCOVERY IN CURRENCY MARKETSThis paper investigates the price discovery process in the foreign exchange market. Understanding exactly how information becomes embedded in exchange rates is central to current efforts to understand exchange-rate dynamics (see, for example, Evans and Lyons (2002), (2004)). Within microstructure per se there is also a powerful incentive to study foreign exchange trading, since the currency market dwarfs all others. Nonetheless, the overall contours of price discovery in foreign exchange remain murky.Our paper makes three contributions, all of which build on the observation that the foreign exchange market has two tiers, similar to the London Stock Exchange and some bond markets. In one, dealers trade with each other; in the other, dealers trade with (non-dealer) customers. The paper first provides evidence that spreads in the customer market are inversely related to a trade's likely information content, which implies that price discovery in FX cannot be determined by adverse selection. Second, the paper suggests three potential sources for this pattern of customer spreads, two of which are based on the information structure of the market. Finally, the paper proposes a price discovery process centered on dealers' inventory management strategies in the interbank market and provides evidence for that process. Since this process reflects the foreign exchange market's two-tiered structure it has the potential to be relevant in liquid two-tiered markets for other assets.The adverse-selection-based price discovery process, articulated in Glosten and Milgrom (1985) and Easley and O'Hara (1987), among other important works, asserts that dealers build into their price quotes the potential information revealed by a given cu...

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