An Examination of Profitability and Risk-Taking Behavior in Futures Market

This paper examines the profitability and risk-taking behavior of individual traders in the Taiwan Futures Exchange (TAIFEX) by tracking their trade-by-trade transaction histories. We first show that although as a group individual traders have a net loss after all transaction costs, there are fairly profitable traders, accounting for about 1/3 of the traders. Further examination reveals that profitability varies systematically with trading frequency and volume. Focusing on the frequent and high-volume traders and following their trades as they steadily accumulate and offset contract positions, we analyze their risk-taking behavior by examining their responses after reaching some threshold levels of losses and gains. We then investigate whether they vary in their responses and link the variations to their profitability. We show that in aggregate they tend to offset their trades after reaching some threshold levels of losses and gains. However, the tendency to offset positions varies among them in a systematic fashion, which in turn affects their profitability differently depending on whether they are profitable or not. Among profitable traders, those who have a greater tendency to offset their trades in the face of threshold losses and gains are less profitable. On the other hand, among unprofitable traders, those who tend to offset their positions when faced with the threshold losses and gains suffer smaller losses. In contrast to the evidence from previous studies that examine the aggregate trader, the results from this study shed new light that challenges the general conclusions on the profitability and overconfidence in the literature. The results also have practical implications for traders in view of the linkage between profitability and risk-taking trading strategies.