Do Behavioral Biases Affect Prices?
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What they found
Using every trade by proprietary market makers in Treasury bond futures on the Chicago Board of Trade during 1998, the authors found that professional traders with morning losses took significantly more risk in the afternoon than traders with morning gains, and that this loss-driven risk-taking was unprofitable. Traders who had lost in the morning bought at higher prices and sold at lower prices than their peers, and their afternoon trading reversed prices, meaning the bias was strong enough to move the market briefly. The behavior is consistent with loss aversion and the break-even effect from prospect theory.
What you can use
- Professional floor traders who were losing on the day took more risk to get back to even, and it cost them; this is the revenge-trade pattern in elite traders.
- The effect was large enough to leave a footprint in prices, so it is not a small quirk.
- Daily loss limits exist because even professionals cannot be trusted to size correctly after a losing morning.
Caveats
One year of data on one pit in 1998; floor trading is gone, though the psychology is not. Trader identities and full P&L are not observable, only the pattern.
Tags: professional, loss-aversion, break-even, futures, floor-traders
Summaries are our own reading of the paper, not the authors' words. Educational only, not advice. Discuss it in Book Club.