New paper on retail trader performance

‘The Performance and Persistence of Individual Investors: Rational Agents or Tulip Maniacs?’ is an interesting academic paper by Rob Bauer and Mathijs Coseman that examines the performance of 68,000 retail trading accounts held at a Dutch brokerage between January 2000 and March 2006, covering eight million trades in stocks, bonds and derivatives. They produce some very interesting, if dismal, findings on retail trader performance:

On trade frequency

“Gross returns of the most active traders are higher than those of less active traders but the picture reverses in terms of net performance.”

– On account size

“Account value is positively related to performance.”

“Investors with large accounts have higher gross returns and their performance is hurt less by trading. Investor age does not seem to be related to performance differentials.”

“The quintile of largest accounts outperforms the smallest quintile by almost 2% per month in terms of net returns and 1.5% in terms of net alpha, which is significant at a 1% level.”

Do women make traders?

“We show that women earn higher net returns than men, partly due to higher trading costs incurred by men. Women outperform men particularly in the period of stock market decline, consistent with the notion that women are more risk averse.”

“Controlling for other characteristics, women outperform men by 0.35% a month.”

“Approximately 10% of accounts in the top deciles are held by a woman compared to 5% of accounts in the bottom deciles.”

– On trader performance and persistence

“We find strong evidence of performance persistence among individual investors. Investors who belong to the top decile based on past one-year performance continue to outperform investors in the bottom decile by 1.5% (gross alpha) and 2.8% (net alpha) per month.”

“Performance persistence is somewhat weaker on shorter horizons but still significant for 6-month periods. We find no evidence of persistence on three-month horizons.”

“The average investor earns negative gross and net returns after accounting for risk and style tilts.”

“None of the decile portfolios manages to beat the market consistently. Gross alphas for the top deciles are close to zero. Net alphas are negative for all portfolios and significant for the bottom three deciles.”

“the bottom deciles tend to consist of small accounts with high turnover that are predominantly held by men. Investors in the bottom decile portfolio lose more than 90% of value between 2000 and 2005.”

“… the average net return for the full sample period is -1.76% per month..”

“The relative underperformance of derivatives traders when the general market movement is upward suggests that they have bad market timing skills. After the large stock market decline in 2001 and 2002 investors were bearish about market prospects and expected a further fall. However, it is important to realize that clients of the brokerage firm cannot sell stocks short. The only way to speculate on a market decrease is through the use of derivatives.”

“Our results suggest that the trades of active traders seem to be motivated by some information signals, since they generate positive gross alphas. Nevertheless, these gains are insufficient to offset trading costs. This conclusion is in line with findings of Barber, Lee, Liu and Odean (2004), who document that although heavy traders earn gross profits, these are not large enough to cover transaction costs.”

“The results indicate that the top decile continues to outperform the bottom decile in the year subsequent to the formation year by on average 1.20% per month in terms of gross return and 2.39% in terms of net return.”

Concluding comment

“Finally, age of the investor does not seem to be related to performance persistence. In sum, accounts with high value, low turnover and held by a woman tend to perform best. ”

(Hat tip: CXO Advisory)

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2 responses to “New paper on retail trader performance

  1. to sum up your post…(a) give up my trading quest, (b) become a gigilo, (c) marry a hot (or not so hot) woman with a large portfolio…sounds good

  2. Hah, yes, I think that’s the ‘between the lines’ message of the paper!

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