Day Traders, Noise, and Market Makers

Using data with trader identities for all transactions in SENSEXindex stocks on the Bombay Stock Exchange, we document how noise trading impacts market makers. We identify individual day traders (IDT) as noise traders. IDT contribute 10% to volume and lose consistently to others, including proprietary day traders (PDT), the primary intraday-liquidity providers, and longer-term traders. Instrumental variable regressions show that IDT activity increases PDT activity both intensively and extensively, but PDT profitability stays unchanged, consistent with competitive PDT. Our paper demonstrates competition among market makers, is a crucial link between increased noise trading and reduced bid-ask spread in informed trading models.