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If you sat up late last night watching a horror film and then decided this morning to sell some of your stock- perhaps earlier than you had intended - it might be down to the fact that you gave yourself a fright last night.
Research into individual investors who trade stocks online has examined to what extent emotions can influence individual investors’ decisions. In Fear, social projection and financial decision making, academics Eduardo Andrade, an associate professor of marketing at the Haas School of Business University of California, Berkeley and Chan Jean Lee, a PhD student also in the Haas marketing group, suggest that an individual will frequently rely on their own emotional state and inclinations when they are anticipating others state of mind and preferences - a condition known as “social projection”. In a stock market situation this will mean for example that an individual can make a decision on whether or not to sell their stock based on their predictions of what they anticipate that other investors will do. Such a decision is to some extent dependent on the individual’s current emotions. So a fearful investor, inclined to sell his stock, is more likely to assume that other investors are also fearful and about to sell.
To prove their point the researchers conducted a series of experiments. In one they showed participants either film clips from horror films or from documentaries. They found that scared investors tended to sell their stock earlier than those in a more balanced frame of mind, especially when they believed that the value of the stock was investor driven, rather than computer driven.
The research will appear in the Journal of Marketing Research.
And still looking at the role that emotions play in the stock market, academics have examined the effect that previous experience of a stock has on an investor.
They have discovered that investors are more likely to repurchase a stock which they sold for a profit and can then repurchase at a lower price and are less likely to repurchase stock that they previously sold for a loss or stocks that have become more valuable since they were last sold.
Brad Barber at the Graduate School of Management, University of California, Davis, Terrance Odean, Haas School of Business, University of California, Berkeley and Michal Strahilevitz at the Ageno School of Business, Golden Gate University, San Francisco, suggest that investors repeat actions that “previously resulted in emotional pleasure” while at the same time avoiding those actions that led to pain - the disappointment of buying a stock and then selling it for a loss. And they say that since many individual investors look at their portfolios regularly they are reluctant to “avoid painful reminders of prior losses”- repurchase stock they had sold at a loss which would then remind them of their disappointment each time they looked at it.
The writers say that in common with other economic behaviour, stock trading is affected by emotions and consequently it “is not surprising that investors are attracted to stocks that have treated them well in the past, but shy away from stocks by which they were once burned”.
Once burned, twice shy: how naive learning, counterfactuals, and regret affect the repurchase of stock previously sold is published in the Journal of Marketing Research.