June 7, 2011
Buying the Same Stock - Again: Pride and Regret Drive Investors' Decisions
How likely are you to repurchase a stock you sold? New findings about investor behavior conclude that trading patterns involving previously owned stock are driven by a desire to avoid or at least limit anticipated regret. In other words, investors are likely to repurchase a stock if the sale boosts feelings of satisfaction. This occurs under three scenarios.
Professor Terrance Odean, who studies behavioral finance, reviewed more than 700,000 stock purchases and found that investors are one-half to two-thirds more likely to 1) repurchase stocks previously sold for a gain rather than stocks they previously sold for a loss, 2) repurchase stocks that have lost rather than gained value following a prior sale, and 3) purchase additional shares of stocks that have lost rather than gained value since being purchased.
"Investors are not in a position to forecast but they have a good sense of which transaction makes them feel better about investing, or less good," says Odean, professor of finance at the University of California's Haas School of Business.
The paper, Once Burned, Twice Shy: How Na´ve Learning, Counterfactuals, and Regret Affect the Repurchase of Stocks Previously Sold, is co-authored by UC Davis Professor Brad M. Barber and Golden Gate University Associate Professor Michal Strahilevitz and is forthcoming in the Journal of Marketing Research. The study of actual market trades found investors make decisions based on emotional returns of pride and contentment.
Odean says none of the trading patterns in the study seemed to benefit investor returns. "We find that this basic behavior of buying back previously owned stocks that have gone down in value clearly does not benefit people financially. There is mild evidence that they are worse off for doing that," says Odean.
Odean and his colleagues analyzed two sets of investment records.
The first set included over 3 million trades amongst 78,000 households at a large discount brokerage firm from January 1991 to December 1996. During this period, there were slightly more purchases than sales, with an average trade price of $31 per share. The average household held 4.3 stocks worth $47,334; the median household held 2.61 stocks worth $16,210. The second set included about 665,000 investors at a large retail brokerage who executed over 10 million trades from January 1997 to June 1999. The average household held 5.5 stocks worth about $107,000.
Researchers looked at each day an investor made a stock purchase and whether the investor had sold those same stocks during the previous 252 trading days for a gain or loss. The proportion of winning stocks repurchased revealed investors not only prefer to re-buy a stock that was profitable in the past, but they are also more likely to buy such a stock if it has lost value since the time they sold it.
All behaviors were consistent with counterfactual thinking - looking back at what could have been - and investors' desire to avoid regret and instead feel pride.
"Suppose you sell a stock for $100, trading later for $120. If you buy it back, you're going to regret it because it's now more expensive," explains Odean. "On the other hand, if it's trading at $80, now you feel good because you timed it right. Investors choose what they buy and sell to some extent to manage their own emotions."
The paper explains: an investor who sold for a gain has positive associations with investing in that stock. It made him money and he feels good about it so he will repurchase it. If the price is higher than he previously sold it at, according to the researchers, the investor will always anticipate regretting that it would have been better if he had never sold his investment. However an investor is more likely to re-buy a stock that is valued lower than what he sold it for because it will make him feel happy and proud and that he sold at the right time.