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

By Alok Kumar and Ravi Dhar

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.Investor Behavior, Trading Styles, Reference Points, Disposition Effect

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