Why greedy investors miss out on gains
New research by Dr Haoyang (Damon) Yu of AUT's Department of Economics & Finance shows that greed makes investors more likely to sell winners too soon.
Some people are greedier than others.
We can see this playing out across life: in love, in chasing exercise gains - and in how we buy and sell stocks.
Wall Street greed is widely blamed, for example, as a cause of the 2008 financial crisis.
I too like to dabble in the stock market and among hundreds of my regretful “oh damn” trading decisions, I realised that greed sometimes got the better of me.
I wondered, did other investors feel the same? Was greed influencing us to miss out on returns, and do trading platforms have a role to play in this?
It is well-known that investors tend to sell winning assets too quickly, missing out on gains. They also tend to hold onto losing investments for too long.
This behaviour means they do worse financially than they could, and it has a name: The disposition effect.
Researchers have proposed a range of possible explanations, but the source of the disposition effect remains unclear.
Some think investors might make decisions not thinking about their portfolio as a whole, or that they might be overly fearful of losses.
Others say they might be treating different buckets of money differently, with some of it ‘throw away money’. Or perhaps people simply like the positive feeling of locking in gains.
My experience suggested to me that greed is an important part of the picture.
Greed is a stable human trait that has us wanting more and working to keep what we have.
I wanted to find out how it might affect stock trading decisions, so I built a computerised share trading simulation and recruited 244 participants across three experiments. I also gave them personality testing.
The results showed that greedier investors cashed in their gains sooner than most. Greed pushed them to take modest profits rather than allowing time for their money to build. It didn’t matter how adverse they were to losing money, what kind of risks they liked to take or even how experienced a trader they were. The desire for immediate rewards distorted their selling decisions.
I also tested if traders could make better buying and selling decisions if stock price changes were shown in black and white instead of green and red.
Displaying gains in green encouraged investors to sell winning stocks more quickly
The results for the more greedy investors though surprised me. When returns were shown in green, they were even more inclined to sell quickly - but when losses were displayed in red, they were quicker to sell and thereby avoided greater losses.
I also found that whether price changes were shown in percentages or in dollar amounts affected the disposition effect – but in a fascinating twist it was different for low and high-priced stocks.
Percentages increased the disposition effect at low prices. People would sell winners quicker and hang on to losing stocks longer. But at high prices, it was dollars that increased the effect.
It turns out that a 10 per cent gain on a $30 stock looks bigger than a $3 gain - even though they represent the same increase in value.
But how did the more greedy do?
They sold even earlier when an increase in low-priced stock was shown as a percentage. But for high-priced stocks it was the opposite – they were less likely to sell when shown a percentage.
Not being shown the dollar values helped greedy people make better decisions when dealing with larger numbers.
After the simulation had finished, I enjoyed talking with those that took part.
It was striking how many people didn’t see themselves as being greedy when personality tests clearly showed that they were.
People also didn’t always notice the colour and number format changes or consider that they might be affected by them.
Our personalities though, and the way information is presented, can influence investment decisions - sometimes at the trader’s expense.
This article was written by Haoyang (Damon) Yu about his research Greed and Investor Behaviour: Evidence from Experimental Studies on the Disposition Effect, Salience, and Framing. It was originally published in the Sunday Star-Times Brainwaves feature. Read the original on The Post.
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