Retail Investor Trading and Their Bad Habits

There is a very good article by Michael Taylor that has been published by Sharescope on the subject of the behaviour of retail investors, and their bad habits. It is based on an academic article.

I quote from some of it:

“1. Retail investors tend to trade as contrarians after large earnings surprises, both positive and negative”. Retail investors typically love to buy stocks with profit warnings – the old catching a falling knife trade. They are also quick to book profits on stocks with earnings surprises to the upside. This is why “cut your losses and run your winners” is an oft-used phrase. It’s the exact opposite of what the study in the article found retail investors do.

2. Contrarian trading behaviour did not appear to be information-driven on average. The study found that most retail investors were doing their trading post announcement. Rather than taking a view on the stock before the announcement, they were reacting to the surprise (and often as a contrarian).

3. Contrarian behaviour appeared to be attention related. Retail investors were more likely to trade as contrarians more intensely on stocks they held. I believe this is because many retail investors are risk-averse. Rather than cutting their losses, they preferred to take on more risk rather than admit they were wrong. I think this because many of these portfolios that were looked at had significant negative returns compared to the market by going against momentum.”

You can read the full academic article here:

I don’t think I suffer from most of the bad habits mentioned above although I certainly tend to trade post announcements. I cannot see the point of trying to trade on imaginary news and trading before announcements is positively dangerous as there tends to be little trading then so prices can fall for no reason.

But I have seen the above errors many times in the numerous retail investors I have talked to over the years, particularly in the inexperienced ones.

With the gyrations in the market at the moment I am probably trading too often. Should one buy back a stock after it has fallen and you sold it? I certainly do so if the fundamentals suggest it is good value or that the market has temporarily over-reacted to negative news. At present the stock market is being swept by emotions so a couple of rules I would suggest: 1) Wait a few hours before reacting to news and trading unless the news is very clear (and by the time you can react the price will have moved anyway); 2) Make sure you are sober before trading and not distracted by other events – you need a clear head and need to avoid emotional reactions.

You need to accept your mistakes, ditch the losing stocks and run your winners. That means accepting your mistakes on selling as well as buying.  

Roger Lawson (Twitter:  )

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