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More Motivated by Being Right Than Making Money

March 23, 2009 • Posted in Animal Spirits, Individual Investing

Do stock traders learn rationally from past trading experience? In the March 2009 version of their paper entitled “Trading and Learning: How Different Are Different Categories of Investors?”, Sankar De, Vishal Mangla, P. Bhimasankaram and Simran Singh investigate how different categories of traders revise their beliefs about the prospects for future trading success in response to past trading experiences. Using a sample of 124 million transactions on the National Stock Exchange of India within 1.2 million accounts over the period April 2006 through June 2006, they conclude that:

  • The win-loss percentage of recent trades is significantly more important than the bottom-line profitability of these trades in explaining the future trading of individuals. Recent win-loss experience explains about 15% of the variation in future trade size after controlling for past bottom-line level of profitability of trades and and other variables.
  • The effect of recent win-loss percentage:
    • Depends largely on the outcomes of the last five trades.
    • Declines gradually and consistently with individual trader experience.
    • Is much smaller for institutional investors than for the individual investors.
    • Is smaller for foreign institutional investors and domestic institutional investors.
  • In contrast, the effect of past bottom-line level of profitability of trades on future trading is relatively small and similar in magnitude across categories of traders.
  • Results are consistent whether measuring trade returns for the stock or portfolio level and for alternative holding periods.

In summary, evidence suggests that simple win-loss percentages from recent trades influence the future trading behavior of individuals, especially inexperienced traders, far more than does past bottom-line level of profitability of trades. Individual traders may want to consider whether they are motivated more by being right than by making money.

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