Overconfident investors are more likely to sell after a market crash, locking in losses and missing out on market recoveries, says a paper published in the Journal of Behavioral Finance this year.
Selling after a market crash can be one of the biggest mistakes an investor can make. Since 1942, the average bear market for the S&P 500 has lasted little more than 11 months, with an average loss of 37.1 per cent, while the average bull market has lasted more than four years, with an average return of 147.2 per cent, according to First Trust Portfolios L.P.
The implicit assumption is that sellers will time their re-entry into the market accurately.
That is a poor assumption, says a separate study by Dimensional Fund Advisors. It looked at 720 different stock timing strategies and found that only 30 outperformed a buy-and-hold approach.
But before you start digging for the details on those 30 winning strategies, know that they are unlikely to continue working in the future – and the reason they outperformed in the first place was mostly just luck.
As the authors of that study note, “if you ask a large enough number of people to repeatedly flip a coin, someone will flip 10 heads in a row. Similarly, we should expect some strategies to generate outstanding results just by chance if we try enough parameter combinations.”
In the first study, the researchers were able to identify overconfident investors by cross-referencing respondents from two surveys of U.S. investors in 2018 and creating two comparison variables: “perceived investment knowledge” and “actual investment knowledge.”
People were asked to rate their level of investment knowledge, and this formed their perceived investment knowledge score. The surveys also contained 16 questions that could be used to score their actual investment knowledge.
If an investor’s perceived investment knowledge was high but their actual investment knowledge was low, they were categorized as “overconfident” – they didn’t know as much as they thought they did. Conversely, investors with low perceived investment knowledge but high actual investment knowledge were categorized as “underconfident” – they actually knew a lot but didn’t think they did.
Those who rated their knowledge as low and also had low actual knowledge were labelled “accurately unaware” – they knew they didn’t know much. And finally, those who rated their knowledge as high and had high actual knowledge were “accurately aware.”
In response to a 20-per-cent market crash, overconfident investors were more likely than the other groups to sell out of the market. Accurately aware investors were another story: They were more likely to buy.
Overconfident investors were also the most likely to buy cryptocurrencies, use margin accounts, utilize options and trade penny stocks. These more aggressive trading activities tend to be associated with DIY investors.
While not everyone who opens up a discount brokerage account will engage in these activities, the access to these types of products and strategies is arguably too tempting for some. Sign away enough responsibility and you are free to blow yourself up. Caveat emptor.
Discount brokerages are known as order execution only (OEO) platforms and have restrictions on the kind of advice they can give DIY investors. These investors may not want to work with traditional advice channels and instead are turning to social media and other unlicensed sources of information, for better or worse, in tandem with their DIY accounts.
In the meantime, the take-away of the study dovetails with timeless advice: Investor, know thyself. Perception, it turns out, is not reality when it comes to investment knowledge.
Preet Banerjee is a consultant to the wealth management industry with a focus on commercial applications of behavioural finance research.
TORONTO – Canada’s main stock index was down more than 200 points in late-morning trading, weighed down by losses in the technology, base metal and energy sectors, while U.S. stock markets also fell.
The S&P/TSX composite index was down 239.24 points at 22,749.04.
In New York, the Dow Jones industrial average was down 312.36 points at 40,443.39. The S&P 500 index was down 80.94 points at 5,422.47, while the Nasdaq composite was down 380.17 points at 16,747.49.
The Canadian dollar traded for 73.80 cents US compared with 74.00 cents US on Thursday.
The October crude oil contract was down US$1.07 at US$68.08 per barrel and the October natural gas contract was up less than a penny at US$2.26 per mmBTU.
The December gold contract was down US$2.10 at US$2,541.00 an ounce and the December copper contract was down four cents at US$4.10 a pound.
This report by The Canadian Press was first published Sept. 6, 2024.
TORONTO – Canada’s main stock index was up more than 150 points in late-morning trading, helped by strength in technology, financial and energy stocks, while U.S. stock markets also pushed higher.
The S&P/TSX composite index was up 171.41 points at 23,298.39.
In New York, the Dow Jones industrial average was up 278.37 points at 41,369.79. The S&P 500 index was up 38.17 points at 5,630.35, while the Nasdaq composite was up 177.15 points at 17,733.18.
The Canadian dollar traded for 74.19 cents US compared with 74.23 cents US on Wednesday.
The October crude oil contract was up US$1.75 at US$76.27 per barrel and the October natural gas contract was up less than a penny at US$2.10 per mmBTU.
The December gold contract was up US$18.70 at US$2,556.50 an ounce and the December copper contract was down less than a penny at US$4.22 a pound.
This report by The Canadian Press was first published Aug. 29, 2024.
The crypto market has recently experienced a significant downturn, mirroring broader risk asset sell-offs. Over the past week, Bitcoin’s price dropped by 24%, reaching $53,000, while Ethereum plummeted nearly a third to $2,340. Major altcoins also suffered, with Cardano down 27.7%, Solana 36.2%, Dogecoin 34.6%, XRP 23.1%, Shiba Inu 30.1%, and BNB 25.7%.
The severe downturn in the crypto market appears to be part of a broader flight to safety, triggered by disappointing economic data. A worse-than-expected unemployment report on Friday marked the beginning of a technical recession, as defined by the Sahm Rule. This rule identifies a recession when the three-month average unemployment rate rises by at least half a percentage point from its lowest point in the past year.
Friday’s figures met this threshold, signaling an abrupt economic downshift. Consequently, investors sought safer assets, leading to declines in major stock indices: the S&P 500 dropped 2%, the Nasdaq 2.5%, and the Dow 1.5%. This trend continued into Monday with further sell-offs overseas.
The crypto market’s rapid decline raises questions about its role as either a speculative asset or a hedge against inflation and recession. Despite hopes that crypto could act as a risk hedge, the recent crash suggests it remains a speculative investment.
Since the downturn, the crypto market has seen its largest three-day sell-off in nearly a year, losing over $500 billion in market value. According to CoinGlass data, this bloodbath wiped out more than $1 billion in leveraged positions within the last 24 hours, including $365 million in Bitcoin and $348 million in Ether.
Khushboo Khullar of Lightning Ventures, speaking to Bloomberg, argued that the crypto sell-off is part of a broader liquidity panic as traders rush to cover margin calls. Khullar views this as a temporary sell-off, presenting a potential buying opportunity.
Josh Gilbert, an eToro market analyst, supports Khullar’s perspective, suggesting that the expected Federal Reserve rate cuts could benefit crypto assets. “Crypto assets have sold off, but many investors will see an opportunity. We see Federal Reserve rate cuts, which are now likely to come sharper than expected, as hugely positive for crypto assets,” Gilbert told Coindesk.
Despite the recent volatility, crypto continues to make strides toward mainstream acceptance. Notably, Morgan Stanley will allow its advisors to offer Bitcoin ETFs starting Wednesday. This follows more than half a year after the introduction of the first Bitcoin ETF. The investment bank will enable over 15,000 of its financial advisors to sell BlackRock’s IBIT and Fidelity’s FBTC. This move is seen as a significant step toward the “mainstreamization” of crypto, given the lengthy regulatory and company processes in major investment banks.
The recent crypto market downturn highlights its volatility and the broader economic concerns affecting all risk assets. While some analysts see the current situation as a temporary sell-off and a buying opportunity, others caution against the speculative nature of crypto. As the market evolves, its role as a mainstream alternative asset continues to grow, marked by increasing institutional acceptance and new investment opportunities.
