Reuters is out with an article entitled Hormones, incentive, experience make best traders. The article reviewed a recent study entitled A Note on Trader Sharpe Ratio by John Coates, a Cambridge research fellow in neuroscience who previously worked on Wall Street.
The study analyzed the effects of hormones and experience on the trading performance of 53 English traders averaging 29 years old. These prop traders are incentivized not with monetary bonuses, but with year-end stock gifts based on their performance. Importantly, the study uses the Sharpe Ratio as a measure of risk-adjusted performance over time.
Couple of takeaways from the article:
- Another stab at EMH: By looking at the effects of work experience and performance, as measured by the Sharpe Ratio, the study marks another reference point at the weakness of the Efficient Market Hypothesis to account for consistent, market-beating gains. The researchers compared traders’ Sharpe ratios with the Sharpe ratio of the DAX German stock market index and found that more experienced traders scored significantly higher — an average of 1.02 compared with the Dax’s average 0.53.
- Practice makes profits: The study found that Sharpe Ratios actually went up over time which signifies that traders were getting better at managing risk and squeezing out returns. According to the study: “Our data thus suggest that Sharpe Ratios increase over time because traders learn to make more money per unit of risk they take.”
- Hormones and trading: Whether self-selected or improved via biology, testosterone plays an important part in the work of financial traders, with evidence that male traders will make much more aggressive trades on days when their testosterone is high. According to the study, successful traders “are more profitable and survive longer in the markets, as was previously reported, but we now find the effect is largely mediated through a higher tolerance for risk”.
In the words of its co-author, this study demonstrates that “in trading, as in sports, biology needs the guiding hand of experience.” It’s an interesting look at the interaction of experience, biology, and investment outperformance.