Trading Behavior Of Individual Investors Research Articles

Stock Return Comovement around the ESG Index Revision in Korea

This article examines the impact of additions or deletions to the ESG index on stock return comovement in the Korean stock market over a 10-year period from 2010 to 2019, using eight ESG indices. Our results show that firms added to the ESG index experience an increased beta, both in the short- and long-term, while deleted stocks from the ESG index show significant decreases in beta. The return comovement following ESG index changes identifies not only the initial ESG index but also the new ESG index launched in 2015. However, comovement to the ESG index inclusion is more pronounced with the initial ESG index. Moreover, we find that comovement largely accounts for the trading behavior of individual investors and is partially related to foreign investors’ trading. Our findings are consistent with previous evidence on comovement with changes in major market index constituents and suggest that ESG index revision by considering non-financial factors also induces stock return comovement. These results can be explained by the investor sentiment-based views.

Nonlinear intraday trading invariance in the Russian stock market.

Using high-frequency transaction-level data for liquid Russian stocks, we empirically reveal a joint nonlinear relationship between the average trade size, log-return variance per transaction, trading volume, and the asset price level described by the Intraday Trading Invariance hypothesis. The relationship is also confirmed during stock market crashes. We show that the invariance principle explains a significant fraction of the endogenous variation between market activity variables at the intraday and daily levels. Moreover, our tests strongly reject the mixture of distributions hypotheses that assume linear relationships between log-return variance and transaction intensity variables such as trading volume or the number of transactions. We demonstrate that the increase in the ruble risk transferred by one bet per unit of business time was accompanied by the rise in the average spread cost. Different aggregation schemes are used to mitigate the impact of errors-in-variables effects. Following the predictions of the Information Flow Invariance hypothesis, we also study the relationship between trading activity and the information process approximated by either the flows of news articles or Google relative search volumes of Russian stocks over the 2018–2021 period. The evidence suggests that a sharp increase in the number of retail investors who entered the Moscow Exchange in 2020 entailed a higher synchronization between trading activity and search queries in Google since February 2020, in contrast to the arrival rates of news articles. The changes are driven by the increasing influence of the trading behavior of individual investors using Google Search rather than professional news services as the main source of information.

News and Intraday Retail Investor Order Flow in Foreign Exchange Markets

This paper examines the trading behavior of individual investors using a proprietary intraday dataset of a large pool of retail investor aggregate (minute by minute) long and short positions in EUR/USD for the period July 2014 to April 2016. Standard event study analysis shows no significant adjustment in trading ahead of scheduled macro news announcements and trading contrary to the announcement surprise after the event. A panel regression analysis shows that the contrarian trading behavior is mostly driven by lagged returns rather than fundamental macro news. Further intraday time series analysis shows that the lagged overall news sentiment also significantly affects investor net order flow. Finally, we show that simple cross-over trading strategies that exploit retail investor order flow imbalance are profitable. Overall our results suggest that retail investors in currency markets follow the news and are influenced by news sentiment and past returns, but do not possess the skills to extract fundamental information from public news. Their trading behavior contributes to the slowdown of the price discovery process. Our findings support the differential abilities of market participants to interpret public information as an explanation for the importance of order flow in price formation in currency markets.

The Variation in Variance Risk Premium and its Predictive Power: Evidence from Option Market Sentiments

We show that the highly volatile variance risk premium (VRP) can be theoretically and empirically reconciled with investor sentiment captured by temporary variation in risk aversion. In an effort to understand the poor predictive power of the VRP in non-U.S. markets, we propose a new investor sentiment index, the Variance Sentiment Index(VSI), obtained from the trading behavior of individual investors. We show that the VSI predicts local return dynamics, in a similar way to what the VRP does in the U.S. market. Moreover, the VSI does not lose its predictive power even in the presence of the global VRP.

How biased is the behavior of the individual investor in warrants?

Based on the actual trading behavior of individual investors in the Portuguese financial market during almost ten years this paper examines the socio-demographic characteristics of retail investors in warrants, and discusses the hypothesis that some behavioral biases do have an impact on the investors’ predisposition to invest and trade in warrants, a complex financial instrument. One finds that there is a profile of investors in warrants: younger and less educated men are more likely to invest in warrants and that overconfident, disposition-prone and investors exhibiting a gambling attitude are more likely to invest and trade in warrants. Secondly, the gambling motive seems to be a distinguishing characteristic of investors in warrants. In other words, when investors are driven to trade in financial markets for pleasure/fun they tend to trade complex products more and to trade simple and easier to understand financial instruments less. Finally, the higher the intensity of trading the more relevant are the disposition and the gambler’s biases.

The investor in structured retail products: Advice driven or gambling oriented?

Structured retail products (SRP) are one of the most visible faces of financial innovation and are becoming increasingly popular amongst retail investors. However, there is strong consensus that retail investors’ preference for structured products is difficult to explain using the standard rational theory, those products being in general sold at a significant premium. Studying the actual trading behavior of individual investors we provide evidence consistent with the view that SRP likely offer value to some informed investors compared to other products, and that SRP allow investors to access segments otherwise not available to them. Nonetheless, our results also suggest that the increasing popularity of SRP is deeply related to investors’ behavioral biases, particularly overconfidence and gambling.

Individual Investor Trading in Leverage Products - Risk Appetite and Positioning Around Earnings Announcements

We study the trading behavior of individual investors in leverage bank-issued products around earnings announcements. The trading activity increases substantially around earnings announcements. Aggregated individual investor trading is strongly correlated, both pre- and post event. We find intense aggregate positive positioning ahead of earnings announcements, irrespective of the direction of the subsequent earnings surprise. Thus, individual investors are subject to an optimism bias. The risk appetite of individual investors increases in the run-up to earnings announcements. We find that neither pre-event risk appetite nor pre-event imbalances can be attributed to informed trading. We attribute the increased risk appetite to investor overconfidence. Overall, individual investor trading in leverage products is not particularly skillful.

The Behavior of Individual Investors

Abstract We provide an overview of research on the stock trading behavior of individual investors. This research documents that individual investors (1) underperform standard benchmarks (e.g. a low-cost index fund), (2) sell winning investments while holding losing investments (the “disposition effect”), (3) are heavily influenced by limited attention and past return performance in their purchase decisions, (4) engage in naive reinforcement learning by repeating past behaviors that coincided with pleasure while avoiding past behaviors that generated pain, and (5) tend to hold undiversified stock portfolios. These behaviors deleteriously affect the financial well being of individual investors.

Buying and Selling Behavior of Individual Investors in Option-Like Securities

We analyze the trading behavior of individual investors in option-like securities, namely bank-issued warrants, and thus expand the growing literature of investors behavior to a new kind of securities. A unique data set from a large German discount broker gives us the opportunity to analyze the trading behavior of 1,454 investors, making 89,958 transactions in 6,724 warrants on 397 underlyings. In different logit regression, we make use of the facts that investors can speculate on rising and falling prices of the underlying with call and put warrants and that we also have information about the stock portfolios of the investors. We report several facts about the trading behavior of individual investors in warrants that are consistent with the literature on the behavior of individual investors in the stock market. The warrant investors buy calls and sell puts if the price of the underlying has decreased over the past trading days and they sell calls and buy puts if the price of the underlying has increased. That means, the investors follow negative feedback trading strategies in all four trading categories observed. In addition, we find strong evidence for the disposition effect for call as well as put warrants. The trading behavior is also influenced if the underlying reaches some exceptionally prices, e.g. highs, lows or the strike price. We show that hedging, as one natural candidate to buy puts, does not play an important role in the market for bank-issued warrants. The probability to buy calls is positively related to the holding of the underlying in the portfolio, meaning that investors tend to leverage their stock positions, while the relation between put purchases and portfolio holdings of the underlying is negative. Differences in the trading behavior in warrants with stock market indexes or single stocks as underlings are small.

Don’t Confuse Brains with a Bull Market: Attribution Bias, Market Condition, and Trading Behavior of Individual Investors

By comparing the trading behavior of individual investors in different market conditions, this paper tests the theory that attribution bias - inflated confidence in one’s own skill - creates overconfident traders. In a bull market, investors incorrectly attribute trading successes (luck) to their own abilities and therefore should be more overconfident than they are in a normal or a bear market. Consistent with this argument, we find that in a bull market investors exhibit more overconfidence indicated by the extent of excessive trading. This finding cannot be explained by alternative explanations such as disposition effect and the tendency to gamble.

Don’t Confuse Brains with a Bull Market: Attribution Bias, Market Condition, and Trading Behavior of Individual Investors

Theory predicts that attribution bias creates overconfident traders and thus causes excessive trading in the market. This paper tests this prediction by comparing the trading behavior of individual investors in different market conditions. In a bull market, investors suffer more from attribution bias and therefore should be more overconfident and trade more excessively. Using the trading records of Chinese individual investors from January 2005 to November 2008, we find that individual investors trade more excessively, measured by higher turnover and poorer performance, in a bull market than in a bear market.

Do Noise Traders Move Markets?

We study the trading behavior of individual investors using the Trade and Quotes (TAQ) and Institute for the Study of Security Markets (ISSM) transaction data over the period 1983 to 2001. We document three results: (1) Order imbalance based on buyer- and seller-initiated small trades from the TAQ/ISSM data correlate well with the order imbalance based on trades of individual investors from brokerage firm data. This indicates trade size is a reasonable proxy for the trading of individual investors. (2) Order imbalance based on TAQ/ISSM data indicate strong herding by individual investors. Individual investors predominantly buy (sell) the same stocks as each other contemporaneously. Furthermore, they predominantly buy (sell) the same stocks one week (month) as they did the previous week (month). (3) When measured over one year, the imbalance between purchases and sales of each stock by individual investors forecasts cross-sectional stock returns the subsequent year. Stocks heavily bought by individuals one year underperform stocks heavily sold by 4.4 percentage points in the following year. The spread in returns of stocks bought and stocks sold are greater for small stocks and stocks heavily traded by individual investors. Among stocks heavily traded by individual investors, the spread in returns between stocks bought and stocks sold is 13.5 percentage points the following year. Over shorter periods such as a week or a month, a different pattern emerges. Stocks heavily bought by individual investors one week earn strong returns in the subsequent week, while stocks heavily sold one week earn poor returns in the subsequent week. This pattern persists for a total of three to four weeks and then reverses for the subsequent several weeks. In addition to examining the ability of small trades to forecast returns, we also look at the predictive value of large trades. In striking contrast to our small trade results, we find that stocks heavily purchased with large trades one week earn poor returns in the subsequent week, while stocks heavily sold one week earn strong returns in the subsequent week.

Individual versus institutional investors and the weekend effect

Since the late 1980’s, considerable research has focused on the behavior of individual versus institutional investors and the potential patterns which may emerge from their trading activities. Miller (1988) and Abraham and Ikenberry (1994) posit that the tendency for negative Monday returns on equity (i.e., the weekend effect) is at least partially explained by the trading behavior of individual investors. Sias and Starks (1995), on the other hand, present empirical evidence showing a dominant role played by institutional traders. This study contributes to the literature by distinguishing between individual versus institutional trading as it relates to the weekend effect. We find that the information-processing hypothesis is consistent with observed institutional trading patterns, thus supporting the results of Sias and Starks (1995). In addition, these results are shown to be robust with respect to market type (i.e., auction and dealer markets).

The Individual Investor and the Weekend Effect

It is well known that stock returns, on average, are negative on Mondays. Yet, it is less well known that this finding is substantially the consequence of returns in prior trading sessions. When Friday's return is negative, Monday's return is negative nearly 80 percent of the time with a mean return of −0.61 percent. When Friday's return is positive, the subsequent Monday's mean return is positive, 0.11 percent. This relationship is stronger than for any other pair of trading days and is most acute in small- and medium-size companies. The trading behavior of individual investors appears to be at least one factor contributing to this pattern. Individual investors are more active sellers of stock on Mondays, particularly following bad news in the market.