Are the least successful traders those most likely to exit the market? A survival analysis contribution to the efficient market debate

Concerns regarding the assumptions of the Efficient Market Hypothesis have led to a greater emphasis on how the behaviour of different groups of traders might impact the evolution of financial markets; ideas encapsulated in the Adaptive Markets Hypothesis (AMH). A key assumption of the AMH is that the dynamics of competition and natural selection will drive ‘noise traders’, those least likely to push prices to efficient levels because they follow sub-optimal trading strategies, to exit the market. To test the key assumptions of the AMH, survival analysis is employed to examine the behaviour of retail spread-traders, a group who are widely reported to include many noise traders. Analysis of the trades executed by 5,164 individuals in the period 24th March 2006 to 7th February 2012 found that the least profitable and those who adopted ill-disciplined trading strategies tended to cease trading sooner than others. These findings are consistent with the AMH. However, profitable traders were also found to be more likely to cease trading than the average trader and a V-shaped relationship was found between a trader's Sharpe ratio and their likelihood of ceasing to trade (cf. the average trader). Furthermore, during the financial crisis of 2008-09, the disposition effect of traders and the proportion of noise traders increased and throughout the period of the study, the ill-discipline of new generations of traders increased. The results suggest that the forces underpinning the AMH are complex and the move towards market efficiency may not be as straightforward as some expect.