Proof that Retail Investors Perform Poorly
Using a new database that isolates the activity of retail investors, new research documents their poor performance.
In recent years, a large body of research has demonstrated that many financial anomalies produce stronger results when a greater proportion of participants are relatively uninformed (naive) retail traders. Logically then, stocks with heavier institutional participation should be more efficiently priced and thus produce weaker anomaly results. I provide a summary of the findings and then review new research that takes an innovative approach to measuring investor attention.
Hung Nguyen and Mia Pham, authors of the 2021 study, “Does Investor Attention Matter For Market Anomalies,” examined the impact of investor attention on 11 stock market anomalies in U.S. markets. They found that the anomalies were well explained by measures of investor attention, which were associated with the degree of mispricing; anomalies were stronger following high rather than low attention periods. They concluded: “The results are consistent with the conjecture that too much attention allocated to irrelevant information triggers investor overreaction to information. Once the mispricing is corrected, more anomaly returns are realized following high attention periods.”
Jian Chen, Guohao Tang, Jiaquan Yao and Guofu Zhou, authors of the 2020 study, “Investor Attention and Stock Returns,” examined whether an investor attention index based on 12 proxies could predict the stock market risk premium significantly: abnormal trading volume; extreme returns; past returns; nearness to 52-week high and nearness to historical high; analyst coverage; changes in advertising expenses; mutual fund inflow and outflow; media coverage; search traffic on the Electronic Data Gathering, Analysis and Retrieval (EDGAR) system; and Google search volume. They found that investor attention matters at the market level: It can strongly predict the aggregate stock market in and out of sample when individual proxies are used collectively, yielding sizable gains to mean-variance investors. Conversely, individual attention proxies had limited predictability. They concluded: “There are potentially large investment profits in the asset allocation based on aggregate investor attention, suggesting substantial economic values for mean-variance investors. This analysis then emphasizes the important role of investor attention on the aggregate stock market from an asset allocation perspective. … The predictive power of aggregate investor attention for [the] stock market is likely derived from the reversal of temporary price pressure caused by net buying and from the stronger power for high-variance stocks.”