Abstract
In an experiment, we systematically tested the risk tolerance for trading stock shares that vary in the initial price of the shares. Persons inexperienced with the stock market had to set the selling points for 60 stocks in the case of (a) decreasing or (b) rising prices. First, a stronger risk aversion for falling compared to rising prices was obtained. Second, the experiment revealed a dramatic increase in risk tolerance the lower the buying prices of the stocks were; nearly perfectly following a power function (Pearson-R’s>.93). Furthermore, it seemed very difficult for persons to grasp the consequences of share price neglect, namely that the initial share price has a significant impact on the readiness to take higher risks, whether in a positive or negative direction. Therefore, we are also referring to it as a “hidden risk tolerance”. This paper offers insights into irrational decision making in trading stocks. It allows the formation of estimates regarding trading volume and share price potential on the basis of the initial share price. Furthermore, it provides clues for the consequent reduction of risk-seeking behavior.
Highlights
Humans base typical everyday decisions on rules of thumb or mental shortcuts known as cognitive heuristics, rather than on deep and exhaustive analytical processing [1]
This paper analyzes selling decisions which are merely dependent on the initial buying prices of stocks in order to get insights into the flexibility of risk tolerance
We focused merely on the role of share prices, refraining from all other information usually considered and related with shares such as the volatility or the trading volume of the shares [3] the quality of products or services provided by the associated company, the previous share price performance, the brand value [4] or fundamental economic data such as the credit rating [5] or the growth of the company under scrutiny [6]
Summary
Humans base typical everyday decisions on rules of thumb or mental shortcuts known as cognitive heuristics, rather than on deep and exhaustive analytical processing [1]. “penny stocks”, known as “microcap equities”, refer to shares which trade for a low amount of money, typically smaller than € 1 or $ 1, or, as an alternative definition, to a market cap of low value, e.g., approximately $50 million [7] Penny stocks, which are by definition thinly traded companies within illiquid markets [8] are known to be usual suspects for stock swindlers and trading manipulators [9], as they are often difficult to observe and are infrequently quoted. High-priced shares are mostly called “blue chips”, commonly associated with high-quality and endurable companies. They offer much less volatility, much higher stability and are not so susceptible to easy stock swindling due to their mere size of market capitalization
Sign-in/Register to view highlights & summary 
Published Version (
Free)
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callMore From: International Journal of School and Cognitive Psychology
Disclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
