Blog - Investing Notes
February 6, 2005 – Your Attention, Please! (You Are About to Lose Money)
In their January 2005 paper on "Profiting from Predictability: Smart Traders, Daily Price Limits, and Investor Attention", Mark Seasholes and Guojun Wu examine the counterplay between active individual investors and rational speculators (smart traders) after attention-grabbing events. Exploiting special access to detailed trading data for the Shanghai Stock Exchange during January 2001 through July 2003, they show that:
- Attention-grabbing events (a limited number of individual stocks reaching daily upper price limits) that narrow the set of stocks considered by individual investors lead to attention-based buying (investors buying a stock for the first time).
- Attention-based buying relates to transitory price shocks averaging 1.29% before mean-reverting over the next 10 days.
- Smart traders react by buying immediately after a stock reaches its one-day limit to earn one-day profits of 0.76% after transaction costs.
- 58% of the profits of smart traders relate to liquidity provision (buying from investors who sell on the event day), and 42% relate to taking advantage of next-day attention-based buying.
In summary, reasonably isolated attention-grabbing events are opportunities for profitable day trading. The authors provide arguments for the applicability of their findings to markets in other countries. They find no evidence of private information at work in these scenarios. They believe that smart traders also react to other kinds of attention-grabbing events.
For related research, see our blog entries of 12/29/04 on the role of the media in feeding investor irrationality, 10/30/04 on implicit coordination among small investors, 10/29/04 on the persistent underperformance of small investors who trade actively, 10/22/04 on the level of success of day traders (some of whom consistently make money) and 10/9/04 on evidence of investor herding.
