In the April 2005 version of their paper entitled “One Trade at a Time: Narrow Framing and Stock Investment Decisions of Individual Investors”, Alok Kumar and Sonya Lim investigate whether individual traders take an optimizing big picture (How’s my portfolio doing?) or a suboptimizing little picture (How’s this stock doing?) approach to trading. Using a data on the portfolio holdings and trades of a sample of 41,039 individual investors (with demographics) at a large U.S. discount brokerage house during 1991-1996, they conclude that:
- Clustered trading patterns indicate portfolio-centric (“broad framing”) or big picture trading. Isolated trading indicates stock-centric (“narrow framing”) or little picture trading.
- The degree of trade clustering increases with investor financial sophistication, as indicated by demographics.
- The degree of trade clustering increases over time across the entire sample, suggesting that investors learn to be better traders. (See chart below.)
- Big picture investors are less susceptible to the disposition effect (detrimentally selling winners and holding losers).
- Big picture investors make better diversification decisions, as measured by portfolio volatility.
- Big picture investors outperform little picture investors by 1.84% annually on a risk-adjusted basis.
The following chart illustrates the growth in trade clustering and the associated decline in the disposition effect across the overall sample, suggesting that this group of investors on average takes an increasingly big picture approach to trading. In other words, they learn to be better investors.
In summary, individual investors can look at their own trading patterns for clustering to assess whether they act like big picture or little picture traders.
