LUCK VERSUS FORECAST ABILITY

In Luck Versus Forecast Ability: Determinants of Trader Performance in Futures Markets
(1991) utilizing the same data set and statistical procedures he used in 1987 (above),
Michael Hartzmark builds on the former study by testing for two types of trader forecasting
abilities: (1) consistent forecasting of price direction, and (2) “big hit” ability, where
the trader is able to predict direction plus magnitude, holding the largest positions when
the largest returns are anticipated.
For this study, Hartzmark removes the less active large speculators from the data,
which amount to about half the sample. Unlike the earlier study, the remaining largest
of the large speculators show positive returns. Even though a large number of traders
appear to exhibit significantly superior forecasting ability, Hartzmark concludes that the
statistics are highly supportive of the premise that profits were due to luck, not forecasting
ability.

He focuses on two questions that emerge from his inquiry. First, it is not clear why
there is a massive bunching of traders with no ability—although it suggests that many
individuals use very similar trading strategies or information sources. Second, it is not
clear why a subset of large speculative traders should earn significantly positive returns.
If the performance of all traders, whether large or small, is due to luck, one would not
expect the large traders to consistently perform any better than the small traders. Yet
both in this study and in a number of earlier studies cited by Hartzmark, small traders
are the big losers and large traders are the big winners.