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January 28, 2009 6:32 pm
Marketers of fast-moving consumer goods, like toothpaste, long ago discovered the “left-digit effect” – consumers’ perception of price is skewed by the leftmost digit, so a $1.99 tube of toothpaste sells better than a $2 tube. The other key factor is a short and instantly recognisable brand name.
It turns out that traders in stocks are just as irrational as toothpaste buyers. Two years ago, research from Princeton showed that stocks whose ticker symbol (key information needed to make a trade) could be pronounced as a word beat stocks whose tickers cannot be remembered so easily. Big Lots’ price rose dramatically once its ticker changed from BLI to BIG.
Now, three Indiana University researchers have analysed 100m trades made on Nasdaq, and divided them according to their price point. Sure enough, buy orders outnumbered sells to the greatest extent at prices ending in .99. Sells most outweighed buys at prices ending in .01.
The anomaly is statistically significant and shows up in other ways. It is greatest when the penny brings down the leftmost digit – going from $20 to $19.99 makes a greater difference than from $19 to $18.99. The human need to read numbers from left to right leads to decisions that flout rationality.
The anomaly could persist as long as humans are irrational. In other words, forever.
Ridiculous anomalies like this prompted interest in behavioural economics, which replaces economic axioms of how we should behave with evidence from psychology on how we actually behave.
They also might ensure the long-term survival of computer-driven quantitative trading. Construct a program to take advantage of this, buying at .01 and selling at .99, and keep it going for long enough, and it should beat the market – if it avoids crises like the last year.
Utpal Bhattacharya, Craig W. Holden and Stacey E. Jacobsen, Penny Wise, Dollar Foolish: The Left-Digit Effect in Security Trading (November 18, 2008). Available at SSRN.
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