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If you consider yourself to be a better-than-average
share investor, you’re not alone according to new US research.
A recently-published study by Brad Barber and
Terrance Odean from the University of California found that overconfidence
seems to play a key role in explaining why retail investors underperform
when they switch from phone-based to online trading. This is the
opposite to what one might expect given that 'straight-through'
order processing is widely promoted as a positive development which
leads to faster, more profitable trading results.
To examine the reasons for this deterioration in performance, they
analysed the trading behaviour of 1,607 share investors who switched
from phone-based to online trading during the 1990s. The
results make fascinating reading.
Prior to going online, investors in the sample
typically recorded strong trading performances. On average, they
beat their self-nominated market index by a net 2.4% annually (i.e.
after trading costs). Once online, however, their performance fell
away dramatically. Net of trading costs, they under-performed their
own benchmark by 3.5% per annum.
Other changes in trading behaviour were also noted. After going
online, investors tended to trade more actively and more speculatively
than before. In most cases their portfolios were tilted toward small
growth stocks with a high level of market risk. On this score, there
were striking differences between the sexes with men trading almost
one and a half times more frequently than women and recording lower
net returns.
The authors believe that the deterioration
in investment performance, and associated rise in trading activity,
was mainly because online investors tend to become overconfident.
Three cognitive biases - self attribution bias, the illusion of
knowledge and the illusion of control - appear to play a key role.
(Full story Market Notes - Issue 86. Subscribe)
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