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Individual Investor Trading Motivators

Posted in Animal Spirits, Individual Investing

What makes individual investors trade more or less? In the March 2010 version of their paper entitled “Success/Failure of Past Trades and Trading Behavior of Investors”, Sankar De, Naveen Gondhi, Vishal Mangla and Bhimasankaram Pochiraju investigate how trading results affect future trading. Using detailed trading histories for 1.32 million individual Indian investors  involving 111 million transactions worth $85 billion in S&P CNX Nifty stocks during January 2006 through June 2006, they find that:

  • Individual investors in the sample collectively lost $2.3 billion from trading during the sample period.
  • The sign of past trade outcomes  (positive or negative) has a much larger impact on subsequent trading volume than dollar size of the outcomes. The sign of recent outcomes explains about three-fourths of the variation in subsequent trading volume.
    • After controlling for the size of gains and losses, current trading volume is 7.7% higher for traders with recent positive trades than negative trades.
    • The probability that a trader will increase  trading volume is 1.7% higher for an individual with recent positive trades than negative trades.
  • Individual investors with positive (negative) past trades also tend to trade more (less) frequently. The sign of recent outcomes explains 89%  of the variation in subsequent trading frequency.
    • Current trading frequency is 6.3% higher for traders with recent positive trades than negative trades.
  • On average, profitability of current trades is almost 60% lower for traders with recent positive trades than negative trades. This performance deficit is attributable to the influence of the sign of recent trade outcomes.  The more successful individual investors appear to be those less influenced by the signs of recent trades.

In summary, evidence indicates that the sign (much more than size of profit/loss) of recent trades influences the future trading behavior of individual investors. This influence is adverse to overall profitability.

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