1. Correlated Trading and Returns
Daniel Dorn (Drexel U)
Gur Huberman (Columbia U)
Paul Sengmueller (U of Amsterdam)

2. 37,000 Clients of a Large German Discount Broker in 1998-2000
To what extent are they on the same side of the market?
Stock returns when clients are on the same side of the market?
Stock returns subsequent to clients being on the same side of the market?
Net trade = 0!
Correlation of returns & trading aims at ability to predict market, or even exert a pressure on prices.

3. Lakonishok, Shleifer, Vishny
The impact of institutional trading on stock prices (JFE, 1992)
Data: quarterly frequency.
Conclusion: not much.
LSV herding measure:

4. To what extent are they on the same side of the market?
Bottom trading quartiles
Top trading quartile
Daily
3.5%
5.3%
Weekly
3.6%
5.6%
Monthly
3.8%
6.9%
Quarterly
6.6%
7.9%
For each instance, must have at least 2 active traders
Median LSV measure

5. Stock returns when clients are on the same side of the market?
When clients buy, returns positive
When clients sell, returns negative.

6. Stock returns after clients are on the same side of the market?
After clients have bought, returns positive
After clients have sold, returns negative.

7. Importance of limit orders
If price goes up on a day
Mainly sell limit orders will be executed
Two effects:
Exaggeration of correlated trading
Negative correlation between return & direction of trading.

8. Half the trades are SPECULATIVE
LSV Measures
Non-speculative
market
orders
Speculative
Daily LSV
5.8%
5.0%
Weekly LSV
5.7%
6.0%
Monthly LSV
4.5%
7.6%
Quarterly LSV
4.8%
9.3%
Difference becomes important with lower frequency

9. Persistence of buyers ratios
Weeks relative to portfolio formation -1
0 (formation) +1
PF1 (sell)
0.41
0.10
0.37
PF2
0.46
0.43
0.44
PF3 (buy)
0.52
0.77
0.50
PF3-PF1
0.17
0.67
0.12
Even stronger numbers at the daily frequency

10. Weeks relative to portfolio formation
Weekly returns of portfolios based on comovements of speculative trades
Weeks relative to portfolio formation -1 +1
PF1 (Brokerage sell)
0.15
-1.16
0.02
PF2
0.83
0.19
PF3 (Brokerage buy)
2.24
3.52
0.64
PF3-PF1
2.08
4.68
0.61 N
122
Equally weighted, % returns.

11. Weeks relative to portfolio formation
Weekly returns of portfolios based on comovements of NON-speculative trades
Weeks relative to portfolio formation -1 +1
PF1 (Brokerage sell)
1.76
0.63
0.21
PF2
1.11
1.21
0.04
PF3 (Brokerage buy)
0.97
1.37
0.17
PF3-PF1
-0.79
0.75
-0.04 N
122
Note the differences in returns vs. the previous slide

12. Correlated trading & returns
At the weekly frequency,
Trading of these people is positively correlated with returns.
Speculative trading of these people leads subsequent returns.

13. Why contemporaneous correlation?
Same signals that cause price change also cause these people to trade in the same direction.
These people’s trades push prices.

14. Why speculative trading leads returns?
Speculators are good at predicting price changes.
These people’s trades push prices.
These people’s trades are persistent.