Market Timing Skill and Trading Activity in Taiwan’s Retail-Dominated Futures Market

Abstract

There has been substantial research on performance persistence among professional and retail investors. These studies typically employ infrequently sampled data on portfolio holdings and returns, making it difficult to distinguish skill from luck, let alone differentiate between superior security selection and market timing ability. Based on 10 years of comprehensive account-level data comprising 61 million trades made by investors in Taiwan’s retail-dominated futures market, the authors confirm that institutions consistently earn alpha at the expense of behaviorally biased individual traders. The authors introduce an approach for separating overconfident traders from skilled market timers. This novel skill measure interacts prior performance with past trading volume. Investors identified as highly skilled subsequently earn a net-of-cost average annual return of 115%. The authors’ results contribute in two ways: (1) introducing a new measure for assessing high-frequency trading skill and (2) validating the intuition that significant alpha can be harvested by active investors in retail-dominated markets.

TOPICS: Futures and forward contracts, emerging markets, manager selection, performance measurement

Key Findings

• ▪ The authors employ comprehensive data on 61 million individual trades made by investors in Taiwan’s financial futures market over a 10-year period to confirm that behaviorally biased retail investors consistently lose to institutional investors.

• ▪ They demonstrate weak performance persistence and a nonlinear relationship between past trading volume and future performance, characterized by overconfidence on the part of a vast majority of traders and rational learning about skill by the most active traders.

• ▪ The authors describe a method for inferring true market timing ability from a combination of data on prior performance and past trading volume and identify a small subset of skilled traders who subsequently earn extraordinary profits after accounting for transaction costs.