Giant magnetoresistive (GMR) biosensors consisting of many rectangular stripes are being developed for high sensitivity medical diagnostics of diseases at early stages, but many aspects of the sensing mechanism remain to be clarified. Using e-beam patterned masks on the sensors, we showed that the magnetic nanoparticles with a diameter of 50nm located between the stripes predominantly determine the sensor signals over those located on the sensor stripes. Based on computational analysis, it was confirmed that the particles in the trench, particularly those near the edges of the stripes, mainly affect the sensor signals due to additional field from the stripe under an applied field. We also demonstrated that the direction of the average magnetic field from the particles that contributes to the signal is indeed the same as that of the applied field, indicating that the particles in the trench are pivotal to produce sensor signal. Importantly, the same detection principle was validated with a duplex protein assay. Also, 8 different types of sensor stripes were fabricated and design parameters were explored. According to the detection principle uncovered, GMR biosensors can be further optimized to improve their sensitivity, which is highly desirable for early diagnosis of diseases.