Heterogeneity and skill in the retail EUR/USD FX market
: Investigating the impact of uncertainty and behavioural biases of trader skills

Student thesis: Doctoral ThesisDoctor of Philosophy


One of the issues that has been debated in the literature is market heterogeneity. Traditional financial models adopt a popular assumption that markets are efficient and that participants act rationally such that their actions are homogeneous. Nevertheless, behavioural finance literature provides significant evidence of behavioural patterns and biases which render the assumption of homogeneity too simplistic and idealistic. Heterogeneity in financial markets can be defined as significant diversity in expectations of asset prices.
I examine two aspects of heterogeneity in this thesis: trader’s performance and trader’s expectations. I also investigate whether traders possess genuine trading skills and how market volatility as well as a trader’s personal behavioural biases affect their skills. Using a dataset of more than twenty-one thousand retail FX traders on the EUR/USD market I find significant evidence of heterogeneity in performance and expectations, which persists throughout their trading career. I show that while around 68% of traders have the ability to correctly predict future price changes more than half of the time, only around 22.8% have the ability to generate overall positive returns. In addition, around 27% of traders have the ability to favourably adjust their position size based on the magnitude of the change in market prices. Moreover, I find that volatility has a detrimental impact on performance. Nevertheless, as this uncertainty becomes seasoned, individuals learn to understand it and adjust for it in their trading decisions. Finally, I find that skilled traders are herd initiators such that they are closely watched and copied by others. I also show that skilled traders exhibit the disposition effect, whereby they are more likely to realise small gains and hold on to large losses.
In addition, skilled traders are also sensation seekers, indicating that they tend to use leverage to exploit price change; however, they tend to avoid extreme levels of leverage which can be detrimental to the performance and reputation. Skilled traders are more likely to be inconsistent in the amount of leverage and margin they use, which is explained by their ability to adjust their leverage ratio depending on the state of the market and their confidence in their trading decision.
This thesis contributes to the literature on the micro dynamics of retail FX markets. My findings highlight that importance of understanding trader behaviour which provides insight into the decision-making process of individual traders and how these decisions are affected by endogenous behavioural factors as well as external market factors.
Date of Award2018
Original languageEnglish
Awarding Institution
  • King's College London
SupervisorAlex Preda (Supervisor) & Tarik Driouchi (Supervisor)

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