The Long and Short of It: Why Are Stocks with Shorter Runs Preferred?

Abstract

This article examines how consumers process graphical financial information to estimate risk. We propose that consumers sample the local maxima and minima of a graph to infer the variation around a trend line, which is used to estimate risk. The local maxima and minima are more extreme the higher the run length of the stocks (the consecutive number of upward or downward movements of a price series with identical mean, variance, skewness, and kurtosis). Three experiments show that this leads to stocks with higher run lengths being perceived as riskier: the run-length effect. Importantly, the run-length effect is greater for investors who are more educated, are employed full time, trade more frequently, have had longer experience trading, and trade a wider range of financial instruments. Implications for the communication of financial products, public policy, and consumer welfare are discussed, as are theoretical implications for the processing of visual and financial information and behavioral finance.