Wealthier Investors Are Better at Processing News Into Trading Decisions

A study found that individual investors’ performance differs widely based on their wealth and demographics.

Using data on trading and holdings from 53 million retail accounts from the Shanghai Stock Exchange from 2016 to 2019, the researchers found that these investors with larger accounts follow more contrarian strategies, reflect the news in their trades and experience subsequent gains, while smaller accounts tend to follow momentum-based strategies, fail to account for the news when placing trades and incur trading losses. They also found that these trends were stronger for young men.

The researchers saw that the differences between these two groups’ predictive capabilities could be explained by their ability to react to the news. A 2008 study by Brad Barber and Terrance Odean found that “[individual investors] pay more attention to non-essential information rather than fundamental information.” (See “Trading More Frequently Leads to Worse Returns” in the November 2014 AAII Journal.) Trades that occurred with smaller accounts were less correlated with future stock price movements after news; conversely, larger accounts were more correlated. From this, the study’s authors found that “less wealthy [individual] investors predicted earnings surprises with the wrong sign while wealthier ones predicted earnings surprises with the correct sign.”

Looking at the demographic patterns, the researchers found that “male investors of all ages were largely momentum investors, while female investors were mostly contrarian investors.” Relatedly, men tended to negatively predict returns, with the youngest age groups losing the most, while women younger than 35 and older than 55 could positively predict future returns.

In spite of this data, the study’s authors found that “all groups of [individual] investors lose money, though [individual] investors with larger account sizes lose significantly less on average.” They report that the Shanghai Stock Exchange itself sees the differences in these groups of investors and is developing policies to restrict the kind of trading less wealthy accounts can perform, potentially protecting them from leveraged and riskier trades.

Source: “Heterogeneity in Retail Investors: Evidence from Comprehensive Account-Level Trading and Holdings Data,” by Charles M. Jones, Donghui Shi, Xiaoyan Zhang and Xinran Zhang; SSRN, June 2020.