The article under consideration deals with the issue of excessive trading on the world markets. The author attempts to test the hypothesis that the investors trade too much due to their overconfidence in the information about securities. Other researchers are supportive of the idea that excessive trading may take place due to different psychological factors with overconfidence being one of those which are most frequently named (Vick 2000).
It is assumed in the article that overconfidence takes place due to the investors’ misinterpretation of the information about securities available to them. The aims of this article are to illustrate that this misinterpretation may lead to the decrease of the returns on the investments. The author also assumes that this may have certain relation to the overall excessive trading volume which can often be observed on the world market. It is stated in the article that the reasons for the misinterpretation may be different. The author applies different methods to test the hypotheses; he uses appropriate ways to explore the research questions and arranges his study in a way which makes it possible to understand how the analysis of the presented problem has been carried out.
In the course of the research the author tries to determine whether the misinterpretation of information results more often in losses or in profits from the returns on investments. In order to collect the necessary information, the researcher randomly selects ten thousand customer accounts; this excludes the possibility of the results of the study being biased. The article gives examples of how the securities which the investors buy can perform or outperform those which they sell.
For instance, the author states that the purchased securities may outperform those which were sold, but the returns are enough to compensate for the transaction costs. However, this is not always the case. The situation is worth when speculative traders misinterpret the information they have about the securities’ value, which results in the bought securities outperforming those which were sold; at this, the returns may not be enough even for covering the transaction costs.
Therefore, in case the traders are overconfident about the precision of information, this may result in significant losses for them. One of the findings of this article shows that in most of the cases the securities which the investors buy underperform those securities which they sell with the return being 3.3 percent lower (Odean 1999). This means that the investors who buy securities because of the lack or misinterpreting of the information about them are making unprofitable trades. To reach his main aims, the researcher traces the difference in returns on the investments which the investors make into the securities during different periods of time (four months, a year, and two years).
The average return on the investments is then calculated. This is done by means of calculating the prices of the securities on the day they were purchased and their closing price, and comparing the results with the difference between the closing price and the selling price of these securities. Thus, the author discovers that an investor needs no less than 6 percent return on the investment in order to only cover the transaction costs. Otherwise, the deal will be simply unprofitable.
These data allow the author to test his hypotheses. Firstly, he proves that the round-trip trading cost of the securities is higher than the difference between the returns on the bought and the sold securities (irrespective of whether the period of time is four months, a year, or two years). This means that the investors are likely to suffer losses if they are overconfident about the information they have regarding the securities. The second hypothesis which is tested by means of this experiment is that for the period of time under consideration the return on the securities which have been sold is higher than the return on the securities which have been purchased, which testifies to the fact that the investors misinterpret the information they have about the securities.
Furthermore, the researcher explores the returns patterns which particular investors exhibited before and after transactions. He designs special graphs which help to trace the excess in trades and purchases, as well as advises to design similar graphs for tracing these data in the entire market. In general, numerous figures utilized throughout the article illustrate the author’s ideas and facilitate the comprehension of the information. The same goes for the tables in which the data from the author’s calculations are arranged; the tables allow contrasting the data and tracing the change of the returns on securities over a definite period of time.
When researching the returns patterns, the author also mentions the reasons why the investors may misinterpret the information about securities. He emphasizes that the investors are likely to suffer losses if they choose to trade solely. In this case, the information which they possess about the securities often has predictive context, which is why it is understood incorrectly. The sets of information which are interpreted are mostly the same for all the investors.
As a rule, they concern technical indicators, recent returns on the investments, personal knowledge about a particular industry, accounting data, etc. This is why the researcher explores the patterns of the investments before they were bought by the individual investors and after that. The author finds out that there exist certain regularities between the return patters of securities before and after their purchase and sale. In the subsequent section the author explains these patterns.
It should be noted that certain limitations to the study exist. These limitations concern the alternative motivations which the investors may have when purchasing securities. Among these motivations there are a desire to rebalance one’s portfolio, to meet liquidity demands, to move to more risky investments, etc. However, they are carefully explained by the researcher with his further stating that they could hardly influence the results of the study in question.
The article concludes by emphasizing that the excessive trading volume which has been registered with a separate group of investors may mean that the overall excessive trading takes place due to the similar reasons, namely misinterpreting of information about securities.
The article under analysis greatly contributes to the general knowledge about the trading volume on the world market because it addresses a problem widespread for the financial markets. Taking into account that the aims which the researcher has set have been achieved, it can be stated that the analysis presented in the article may be of great help for discovering real reasons why the trade volume on the market is currently excessive.
Reference List
Odean, T 1999, ‘Do Investors Trade Too Much?’, American Economic Review, vol. 89, no. 5, pp. 1279-1298.
Vick, TP 2000, How to pick stocks like Warren Buffett: profiting from the bargain hunting strategies of the world’s greatest value investor, McGraw-Hill Professional, New York.