How successful is the amateur investor?

However it is a reality that the majority of amateur punters in both fields of gambling do not do very well. In fact, a lot has been written on the behaviour of amateur investors thinking they can pick stocks better than the professionals – and failing to do so!

One observer, Terrance Odean, Foundation Professor of Finance at the University of California, has researched at length and written about the behaviours of amateur investors in stocks and shares. Odean began by studying the trading records of 10,000 brokerage accounts of individual investors spanning a seven-year period. He was able to analyse every transaction the investors executed through nearly 163,000 trades.

This rich set of data allowed Odean to identify all instances in which an investor sold some of his holdings in one stock and soon after bought another stock. By these actions, the investor revealed that he (and most of the investors were men) had a definite idea about the future of the two stocks: he expected the stock that he chose to buy to perform better than the stock he chose to sell.

To determine whether these ideas were well founded, Odean compared the returns of the stock the investor had sold and the stock he had bought in its place, over the course of one year after the transaction. The results were unequivocally bad. On average, the shares that individual traders sold did better than those they bought, by a very substantial margin: 3.2 percentage points per year.

One conclusion must be that if the average investor had any insight, the stocks he bought would outperform the stocks he sold. But in fact, the stocks bought by the average investor performed 3.2 percent worse than stocks he sold. Also, this does not take into account the cost of trading the stocks and so one must assume that when the amateur investor trades better stocks for worse – therefore he also pays additionally for the privilege of doing it!

Commentators on the research findings have suggested that if the investors’ sales and purchases were at random, rather than deliberately selected, then the randomness would mean that the stocks purchased overall over time would perform similarly to the ones sold.

The efforts of the amateur investor have been described as ‘a madness’, with one commentator suggesting that for the vast majority of amateur investors, taking a shower and doing nothing would be a better policy than implementing their own ideas about investments! Do amateur investors ever sign themselves up for ‘Gamblers Anonymous’?