Investor Psychology and Security Market Under- and Overreactions

We study the trading of individual investors using transaction data and identifying buyer- or seller-initiated trades. We document four results: (1) Small trade order imbalance correlates well with order imbalance based on trades from retail brokers. (2) Individual investors herd. (3) When measured annually, small trade order imbalance forecasts future returns; stocks heavily bought underperform stocks heavily sold by 4.4 percentage points the following year. (4) Over a weekly horizon, small trade order imbalance reliably predicts returns, but in the opposite direction; stocks heavily bought one week earn strong returns the subsequent week, while stocks heavily sold earn poor returns.

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Do Retail Trades Move Markets

International Momentum Strategies

We study nearly 7,000 retirement accounts during the April 1994-August 1998 period. Several interesting patterns emerge. Most asset allocations are extreme (either 100 percent or zero percent in equities) and there is inertia in asset allocations. Equity allocations are higher for males, married investors, and for investors with higher earnings and more seniority on the job; equity allocations are lower for older investors. There is very limited portfolio reshuffling, in sharp contrast to discount brokerage accounts. Daily changes in equity allocations correlate only weakly with same-day equity returns and do not correlate with future equity returns.

Portfolio Choice and Trading in a Large 401(k) Plan

We provide an overview of research on the stock trading behavior of individual investors. This research documents that individual investors (1) underperform standard benchmarks (e.g. a low-cost index fund), (2) sell winning investments while holding losing investments (the “disposition effect”), (3) are heavily influenced by limited attention and past return performance in their purchase decisions, (4) engage in naive reinforcement learning by repeating past behaviors that coincided with pleasure while avoiding past behaviors that generated pain, and (5) tend to hold undiversified stock portfolios. These behaviors deleteriously affect the financial well being of individual investors.

/pdf/the-behavior-of-individual-investors-3x08i6k3b6.pdf

The Behavior of Individual Investors

Combining survey responses and trading records of clients of a German retail broker, this paper examines some of the causes for the apparent failure to buy and hold a well-diversified portfolio. The subjective investor attributes gleaned from the survey help explain the variation in actual portfolio and trading choices. Self-reported risk aversion is the single most important determinant of both portfolio diversification and turnover; other things equal, investors who report being more risk tolerant hold less diversified portfolios and trade more aggressively. Less experienced investors similarly tend to churn poorly diversified portfolios. The effect of perceived knowledge on portfolio choice is less clear cut; holding other attributes constant, investors who think themselves knowledgable about financial securities indeed hold better diversified portfolios, but those who think themselves more knowledgable than the average investor churn their portfolios more.

Talk and Action: What Individual Investors Say and What They Do

Combining survey responses and trading records of clients of a German retail broker, this paper examines some of the causes for the apparent failure to buy and hold a well-diversified portfolio. The subjective investor attributes gleaned from the survey help explain the variation in actual portfolio and trading choices. Self-reported risk aversion is the single most important determ- inant of both portfolio diversification and turnover; other things equal, investors who report being more risk tolerant hold less diversified portfolios and trade more aggressively. Less experienced investors similarly tend to churn poorly diversified portfolios. The effect of perceived knowledge on portfolio choice is less clear cut; holding other attributes constant, investors who think themselves knowledgeable about financial securities indeed hold better diversified portfolios, but those who think themselves more knowledgeable than the average investor churn their portfolios more.

/pdf/talk-and-action-what-individual-investors-say-and-what-they-44bgzml06e.pdf

Among 1,000 German brokerage clients for whom both survey responses and actual trading records are available, investors who report enjoying investing or gambling turn over their portfolio at twice the rate of their peers. Including entertainment attributes as additional explanatory variables in cross-sectional regressions of portfolio turnover on objective investor attributes more than doubles the fraction of the total variation of portfolio turnover that can be explained. The results are robust to controlling for gender and proxies for overconfidence constructed from survey responses. Nonpecuniary benefits of trading thus appear to offer a straightforward explanation of the “excessive trading puzzle.”

Trading as Entertainment

A German broker's clients place similar speculative trades and therefore tend to be on the same side of the market in a given stock during a given day, week, month, and quarter. Aggregate liquidity effects, short sale constraints, the systematic execution of limit orders (coordinated through price movements) or the correlated trading of other investors who pick off retail limit orders, do not fully explain why retail investors trade similarly. Correlated market orders lead returns, presumably due to persistent speculative price pressure. Correlated limit orders also predict subsequent returns, consistent with executed limit orders being compensated for accommodating liquidity demands.

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID949414_code173490.pdf?abstractid=949414&mirid=1

Correlated Trading and Returns

Individual and institutional investors can trade German initial public equity offerings on an as-if/when-issued basis before the start of secondary trading. Using a novel data set of pre- and post-IPO trades made by a sample of clients at a large German retail broker, the paper documents that retail investors both are willing to overpay and end up overpaying for IPOs, especially following periods of high returns in recent new issues. IPOs that are more aggressively bought by retail investors in the pre-IPO market or on the day of the IPO post higher first-day returns, but also experience lower aftermarket returns, controlling for firm characteristics such as size and book-to-market ratio. In short, sentiment - expectations about asset values unwarranted by fundamentals - drives retail purchases of IPOs and appears to have a transitory effect on prices.

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID472660_code97182.pdf?abstractid=472660&mirid=1&type=2

Daniel Dorn

Papers

Talk and Action: What Individual Investors Say and What They Do

Talk and Action: What Individual Investors Say and What They Do

Trading as Entertainment

Correlated Trading and Returns

Does Sentiment Drive the Retail Demand for IPOs