Individual Investing

How do typical investors/traders process advice from others? Are they overconfidently dismissive, or underconfidently trading on the latest guru pronouncement? In their February 2006 paper entitled “Effects of Task Difficulty on Use of Advice”, Francesca Gino and Don Moore perform two controlled experiments to examine the tendencies of people to reject or accept advice depending on the complexity of the associated task. In one experiment, the 61 participants (mostly university students) must seek advice, and in the other they have the option of seeking advice. Since the advice came from other participants who were generally no better informed, the best strategy for each participant was to reduce noise by averaging own opinion and advisor’s opinion. Based on the results of these experiments, the authors conclude that: Keep Reading

Is success as an entrepreneur all luck, or is there a provable contribution from skill? Do winners win just because they are willing to roll the dice, or because they consistently bring innovative insights to the market? In their July 2006 paper entitled “Skill vs. Luck in Entrepreneurship and Venture Capital: Evidence from Serial Entrepreneurs”, Paul Gompers, Anna Kovner, Josh Lerner and David Scharfstein pit skill against luck by investigating the persistence of success among serial entrepreneurs. Focusing on the founders of companies listed by Venture Source as recipients of venture capital during the period 1975-2000, they conclude that: Keep Reading

Do mutual fund investors move their money into and out of the stock market at the right times, or the wrong times? In their August 2006 paper entitled “Mutual Fund Flows and Investor Returns: An Empirical Examination of Fund Investor Timing Ability”, Geoffrey Friesen and Travis Sapp examine the flows of funds to/from individual mutual funds to measure the timing ability of fund investors. They define a “performance gap” between the time-weighted (buy-and-hold) return and the dollar-weighted (actual investor average) return as the measure of investor timing ability. Using monthly data for 7,125 mutual funds over the period 1991-2004, they find that: Keep Reading

Do sophisticated (wealthy) investors chase hedge fund returns? If so, should they? In their March 2006 paper entitled “Do Sophisticated Investors Believe in the Law of Small Numbers?”, Guillermo Baquero and Marno Verbeek investigate whether sophisticated hedge fund investors exhibit “hot hands” bias by overreacting to small samples of fund performance. They hypothesize that investors who believe that hedge fund performance is predominantly skill (luck) are prone to overestimate the likelihood of performance persistence (mean reversion) in small samples, leading to an overly trend-following (contrarian) investing style. Using quarterly performance and funds flow data for 752 hedge funds between 1994 and 2000, they conclude that: Keep Reading

How active are active traders? What are the odds that an active trader will make a profit? How are winners different from losers? In their recent paper entitled “The Profitability of Active Stock Traders”, Ryan Garvey and Anthony Murphy examine the outcomes for a large group of active traders over a three-month period. Using data for over 400,000 trades by 1,386 day traders from a direct access broker in the U.S. over the period March 8, 2000 through June 13, 2000 (68 trading days), they find that: Keep Reading

Investors and traders face three hurdles on the track to success: (1) developing a workable strategy/methodology as a foundation for decision-making; (2) persistently performing the research needed to reconfirm/improve/adapt the strategy; and, (3) overcoming emotional temptations to ditch strategy and research by succumbing to fear or greed.  Keep Reading

How often should an investor/trader check the performance of their positions? Does it make a difference (psychologically) whether one checks frequently or infrequently? In their 2005 paper entitled “The Scaling Property of Randomness: The Impact of Reporting Frequency on The Perceived Performance of Investment Funds”, Nigel Finch, Guy Ford, Suresh Cuganesan and Tyrone Carlin use actual investment fund performance data to explore the likelihood that an investor would have viewed the performance as positive or negative based on sampling frequency. Applying prospect theory (a loss in wealth has a negative impact 2.25 times greater in magnitude than the positive impact of a gain in wealth) to data for four large Australian investment funds (see table below), they conclude that: Keep Reading

What personality traits, if any, support successful investing practices? In their March 2006 paper entitled “An Intimate Portrait of the Individual Investor”, Robert Durand, Rick Newby and Jay Sanghani investigate the relationships between personality and both investment decisions and portfolio performance. To measure personality, they apply three perspectives: (1) the “Big Five” personality traits (Negative Emotion-Neurotic, Extraversion, Openness to Experience, Agreeableness and Conscientiousness); (2) psychological gender traits (Masculinity and Femininity); and, (3) personality traits of Preference for Innovation and Risk Taking Propensity. Using personality profiles for 21 Australian self-directed investors along with information about their trading and investment performance during July 2004-June 2005, they conclude that: Keep Reading

What are the essential habits of highly effective (wealthy) investors? In his March 2006 paper entitled “Why do Wealthy Investors have a Higher Return on their Stocks?”, Yosef Bonaparte analyzes data from the triennial Survey of Consumer Finances to find out why the wealthiest investors achieve superior stock returns. To frame the analysis, he defines two types of investment opportunity search: (1) informal (use of magazines, newspapers, online services and friends or relatives); and, (2) professional (use of experts such as accountants, financial planners and brokers). Using results from recent surveys, he concludes that: Keep Reading

What formal studies does academia have to offer on the role of emotions in equity investing/trading? In their October 2004 paper entitled “The Role of Feelings in Investor Decision-Making”, Michael Dowling and Brian Lucey synthesize the results of two threads of recent areas of research on whether and how emotions affect investing: (1) mood misattribution (the impact of environmental factors, such as the weather, the body’s biorhythms and social factors); and (2) image (how investors feel about companies separately from any financial analysis). They note that: Keep Reading