Individual investors tend to trade as contrarians after large earnings surprises. Such contrarian trading contributes to sluggish price adjustment and to momentum.

Studies about the actual trading decisions individual investors make is rare, particularly in the U.S. When a group of three researchers was able to access holdings and transaction data from one of the largest U.S. online brokers, they looked at how individual investors trade around company and macroeconomic news announcements. The researchers analyzed 2.8 million accounts over the period of 2010 to 2014.

The study confirmed that individual investors tend to trade as contrarians around company news announcements. Clients of the brokerage firm sold stocks on large positive earnings surprises and bought stocks following negative large earnings surprises. Moreover, the researchers found evidence of contrarian behavior even after controlling for recent price changes. They believe such contrarian trading might contribute to the underreaction of stock prices to news and the momentum effect (the tendency of outperforming and underperforming stocks to continue outperforming or underperforming, respectively).

The broker data suggested that individual investors have been strongly decreasing their holdings of individual stocks over the sample period. Such a trend implies that institutional and professional investors represent an increasing fraction of stock trading. To the extent that individual investors contribute to momentum, the study’s authors think less participation by individual investors could lead to a declining relevance of momentum in the years to come.

When looking at macroeconomic news (e.g., unemployment data), the researchers found evidence of contrarian individual trading practices; however, they noted that in comparison to company specific news, the effect of macroeconomic news was statistically and economically less significant.

After studying the relationship between individual investors and news announcements, the researchers raised the question of what drives this contrarian trading behavior. They noted that such behavior does not appear to be information driven on average. Investors who trade contrarian on stock news do not appear to trade in advance of the announcement. Instead, this behavior appears to be related to attention: Those who pay more attention to the stocks they hold, as measured by their online activity, trade as contrarians more intensely on news announcements.

Source: “Retail Investors’ Contrarian Behavior Around News and the Momentum Effect,” by Cheng (Patrick) Luo, Enrichetta Ravina, Luis M. Viceira; April 2020.