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A Non-Random Walk Down the Main Street: Impact of Price Trends on Trading Decisions of Individual Investors

Author

Listed:
  • Alok Kumar

    () (Mendoza College of Business)

  • Ravi Dhar

    () (International Center for Finance)

Abstract

We analyze the impact of price trends on trading decisions of more than 40,000 households with accounts at a major discount brokerage house and find that buying and selling decisions of investors in our sample are influenced by short-term (less than 3 months) price trends. We examine investor heterogeneity in trading based on prior returns and classify investors into (i) momentum buy (MB), (ii) momentum sell (MS), (iii) contrarian buy (CB) or (iv) contrarian sell (CS) category. The trading behavior of these investor segments show systematic differences. In particular, we find systematic variations in the response of these investor segments to reference points such as recent high and low prices. Furthermore, consistent with differences in expectations, the disposition effect varies across the investor segments. Our results provide some support to the commonly held belief that relatively more sophisticated investors exhibit contrarian trading behavior. We find that the contrarian investor segment has the best overall performance and their portfolios exhibit better characteristics in comparison to the momentum investor segment.

Suggested Citation

  • Alok Kumar & Ravi Dhar, 2001. "A Non-Random Walk Down the Main Street: Impact of Price Trends on Trading Decisions of Individual Investors," Yale School of Management Working Papers ysm208, Yale School of Management.
  • Handle: RePEc:ysm:somwrk:ysm208
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    Cited by:

    1. Luigi Guiso & Tullio Jappelli, 2008. "Financial Literacy and Portfolio Diversification," EIEF Working Papers Series 0812, Einaudi Institute for Economics and Finance (EIEF), revised Oct 2008.
    2. Fong, Wai Mun & Lean, Hooi Hooi & Wong, Wing Keung, 2008. "Stochastic dominance and behavior towards risk: The market for Internet stocks," Journal of Economic Behavior & Organization, Elsevier, vol. 68(1), pages 194-208, October.
    3. Fong, Wai Mun & Yong, Lawrence H. M., 2005. "Chasing trends: recursive moving average trading rules and internet stocks," Journal of Empirical Finance, Elsevier, vol. 12(1), pages 43-76, January.
    4. Scott Weisbenner & Zoran Ivkovich, 2003. "Local Does as Local Is: Information Content of the Geography of Individual Investors' Common Stock Investments," NBER Working Papers 9685, National Bureau of Economic Research, Inc.
    5. David Colwell & Julia Henker & Terry Walter, 2008. "Effect of Investor Category Trading Imbalances on Stock Returns-super-," International Review of Finance, International Review of Finance Ltd., vol. 8(3-4), pages 179-206.
    6. Oehler, Andreas & Heilmann, Klaus & Lager, Volker & Oberlander, Michael, 2003. "Coexistence of disposition investors and momentum traders in stock markets: experimental evidence," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 13(5), pages 503-524, December.

    More about this item

    Keywords

    Investor Behavior; Trading Styles; Reference Points; Disposition Effect;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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