Do Investors Trade Too Much?

This paper takes a first step towards demonstrating that overall trading volume in equity markets is excessive, by showing that it is excessive for a particular group of investors: those with discount brokerage accounts. One possible cause of excessive trading is overconfidence. Overconfident investors will trade too frequently, that is, the gains overconfident investors realize through trade will be less than they anticipate and may not even offset the costs of trading. By analyzing trading records for 10,000 accounts at a large discount brokerage house, I test whether the securities these investors purchase outperform those they sell by enough to cover the costs of trading. I find the surprising result that, on average, the securities they purchase actually underperform those they sell. This is the case even when trading is not apparently motivated by liquidity demands, tax-loss selling, portfolio rebalancing, or a move to lower-risk securities. I examine return patterns before and after transactions. Return patterns before purchases and sales can be explained by the difficulty of the search for securities to buy, investors' tendency to let their attention be directed by outside sources, the disposition effect, and investors' reluctance to sell short.

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