Confidence and Investors' Reliance on Disciplined Trading Strategies

Abstract

Numerous archival papers indicate that investors can generate profit by following disciplined trading strategies that exploit the market's incomplete adjustment for various accounting data. Even assuming efficient markets in which securities are not mispriced, evidence suggests that both individual and professional investors could improve their returns via disciplined trading strategies like market indexing. Yet, investors rarely follow such strategies. We use two experiments to examine factors that we believe affect reliance on trading strategies by affecting whether investors have more confidence in their own judgment or the recommendation of a trading strategy. We find that MBA-student investors deviate from a trading strategy more when the strategy is less accurate (but still more accurate than most well-known trading strategies), when they trade individual securities instead of portfolios, and when they receive positive feedback on trading decisions made prior to learning about the strategy. Thus, investors may lack the discipline to rely on profitable trading strategies, particularly when recent trading success has increased their confidence in their own judgment (as might occur in a sustained bull market like that experienced over the past decade). Our results also suggest ways that individual investors and portfolio managers can increase reliance on profitable trading strategies.