Another important implication of the learning-about-ability model is that traders increase their trading intensities as they become more experienced, as in
Figure 6
Hazard ratio for survival time of TAIFEX traders conditional on past profitability
The figure reports the hazard ratio for survival time and the 95% confidence interval (dashed lines) for different profit categories relative to the default category of (0.00, 0.05], where the hazard ratio is equal to one by construction. Profits are measured using the Sharpe ratio of returns - dollar profits per contract divided by the standard deviation of dollar profits per contract. The Cox proportional hazard rate model also includes controlling variables associated with trading characteristics, which include average dollar profits per contract over the prior month, standard deviation of dollar profits over the prior month, as well as log trading volume over the prior month.
Mahani and Bernhardt (2007). In other words, profitable traders will increase their trading volume in response to good signals about their ability. To test this prediction, we first calculate the changes in trading volume between the last quarter and the current quarter for each trader in each quarter.13 Second, we split traders into two groups: profitable and unprofitable traders who earn positive and negative profits in the last quarter, respectively. Third, we split traders based on their prior experience into five broad categories. In addition to changes in trading volume, we also analyze the percentage changes in trading volume.
The results are reported in Table 5. Panels A and B respectively list the difference in the increase in trading volume (ratio of traders increasing in trading volume) between profitable and unprofitable traders when experience is measured in terms of the cumulative numbers of contracts and months in the
13 We also calculate monthly changes in trading volume based on different measuring intervals for a robust check and find a similar result.
0 0.5 1 1.5 2 2.5
(-∞,-… (-0.5,-… (-… (-0.4,-… (-… (-0.3,-… (-… (-… (-… (-… (-… (0,0.05] (0.05,… (0.10,… (0.15,… (0.20,… (0.25,… (0.30,… (0.35,… (0.40,… (0.45,… (0.5,∞)
Table 5
Changes in trading volume conditional on experience and past profitability
The left (right) part of Panel A presents the difference of increase in trading volume (of the proportion of traders who increase their trading) from quarter t-1 to t between profitable and unprofitable trader groups when experience is measured in terms of cumulative numbers of contracts. The left (right) part of Panel B presents the difference of increase in trading volume (of the proportion of traders who increase their trading) from month t-1 to t between profitable and unprofitable trader groups when experience is measured in terms of months in the market. Profitable (unprofitable) traders are denoted as those who make positive (negative) money over the prior month. All values are presented in percentage terms. ***, **, and * denote significance at 1%, 5%, and 10% levels, respectively.
Increase trading volume Ratio of traders increasing trading volume Profitable
traders
Unprofitable
traders Difference t-values Profitable traders
Unprofitable traders
Difference t-values
Mean N Mean N
All contracts 4.536 228,190 -1.262 288,158 5.797 4.18*** 0.514 0.400 0.114 45.28***
Panel A: Cumulative numbers of contracts
Contracts≦1,000 2.168 207,835 -0.156 258,712 2.324 31.71*** 0.506 0.405 0.101 42.06***
1000< Contracts ≦3,000 13.490 13,340 -3.751 20,863 17.241 7.94*** 0.509 0.340 0.169 15.23***
3000< Contracts ≦5,000 13.324 2,742 -11.750 4,015 25.074 2.57** 0.513 0.353 0.160 6.93***
5,000< Contracts ≦10,000 150.300 2,032 -91.550 2,758 241.900 1.76* 0.519 0.377 0.142 5.12***
10,000<Contracts≦20,000 32.217 1,061 -3.371 1,005 35.588 0.30 0.494 0.455 0.039 1.05
Contracts >20,000 23.022 1,180 -23.382 697 40.404 0.53 0.522 0.426 0.096 1.12
Panel B: Months in the market
Months≦3 10.626 67994 2.417 83,002 8.208 2.67*** 0.437 0.462 -0.025 -6.53***
3<Months≦6 1.816 48,404 -5.321 63,933 7.136 1.67 0.534 0.353 0.181 40.70***
6<Months≦12 2.378 52,591 -3.363 66,714 5.741 3.40*** 0.515 0.382 0.132 30.78***
12<Months≦24 1.220 43,106 -0.032 52,677 1.252 0.89 0.513 0.399 0.113 23.81***
24<Months≦36 2.961 13,363 -0.776 17,605 3.737 2.08** 0.519 0.379 0.121 14.23***
Months>36 2.732 2,732 -0.702 4,227 3.405 2.09** 0.519 0.311 0.208 11.27***
What do individual traders of TAIEX futures learn from their trading activities?
performance than bad performance, TAIFEX traders seem to display a tendency towards overconfidence.
In addition to changes in trading volume, we also analyze the proportion of traders who increase their trading from quarter t-1 to t. In the right part of Table 5, we find a similar and definite pattern: the ratio of profitable traders who increase their subsequent trading volume (0.514) is larger than that of unprofitable traders (0.400). We find similar results when we use different experience intervals. Overall, more than 50% of profitable traders choose to place more orders, and more than 50% of unprofitable traders choose to trade less actively. This finding shows that learning is an important feature of financial markets; traders who suffer from initial losses and learn that they have no informational advantage or skill trade less actively.
For a robust check, we estimate the proportion of trading that can be attributed to traders with a history of losses. First, we categorize traders at the beginning of each quarter based on their previous quarter’s trading activity and profits. Second, similar to the procedure in Barber et al. (2011), we identify three groups of traders: (1) no prior trades, (2) unprofitable traders, and (3) profitable traders. No prior trades are those with no trading throughout the previous quarter.
Unprofitable (profitable) traders are those who have negative (positive) profits per trade throughout the previous quarter.
Table 6 presents the proportions in each category. Panel A is the trading volume attributed to traders of each group, and Panel B is the number of traders in each group. An inspection of this table shows that the traders who temporarily leave the market after at least a quarter make up the smallest proportion of all trades (11.234%). Those ranked second are the profitable traders. However, although only 17.631% of the traders make money each quarter in the TAIEX futures market, they contribute 30.461% of the trading volume. The vast majority of trading comes from unprofitable traders, who represent 58.305% of all trades and 61.365% of the trading population in the sample period. However, the trade to population ratio for profitable traders (1.73=30.461/17.631) is higher than that of unprofitable traders (0.95=58.305/61.365). In this sense, unprofitable traders appear to rationally learn about their ability and trade less actively after a history of losses. This finding is similar to the results on stock trades in Linnainmaa (2011).
Table 6
Trading volume by traders with no prior trading, unprofitable traders, and profitable traders
This table reports trading volume made by traders with no prior trading, unprofitable traders, and by profitable traders. No prior traders are traders who do not trade in quarter t-1. Unprofitable (profitable) traders have negative (positive) profits per contracts net of costs in quarter t-1.