Blog - Investing Notes

June 21, 2005 – Use the "Cone of Silence" When Buying Stocks?

In the June 2005 update of their paper entitled "All that Glitters: The Effect of Attention and News on the Buying Behavior of Individual and Institutional Investors", Brad Barber and Terrance Odean examine the behaviors of individuals and institutions regarding attention-grabbing stocks. Using four datasets spanning 1991-1999 and focus on three measures associated with attention grabbing events (news, unusual trading volume and extreme returns), they find that:

• Individual investors tend to be net buyers of specific stocks on the days those stocks grab attention, regardless of market capitalization. The buying behavior of professionals is least influenced by attention.
• Individual investors exhibit positive buy-sell imbalances of stocks experiencing abnormally high volume days. Institutional investors display the opposite tendency of the individual investors, with buy-sell imbalances greater on low volume days than high volume days. Value fund managers are particularly aggressive net buyers when trading volume is abnormally low.
• Individual investors have positive buy-sell imbalances for stocks with extreme price moves (up or down). Among institutions, momentum managers dump the previous day’s losers and buy winners, and value managers buy the previous day’s losers and dump winners.
• Investors are much more likely to be net buyers of stocks that are in the news than those that are not.
• Stocks bought by individual investors on high-attention days tend to subsequently underperform stocks sold by those same investors.

In summary, individual investors tend to limit buying consideration, detrimentally, to those stocks that grab their attention via unusual trading or other news.

See also our blog entries of:

5/31/05 on the short-term impact of microeconomic news on the prices of individual stocks;

2/6/05 regarding the counterplay between active individual investors and rational speculators (smart traders) after attention-grabbing events;

12/29/04 on the the role of the media in feeding investor irrationality; and,

10/29/04 and 10/30/04 for related research by Brad Barber and Terrance Odean.