Frequency of stock market trading reduces returns

Research has shown that stock market investors who trade frequently do so at their peril because trading frequently reduces returns. Due to the transactions costs involved, buying and selling shares costs money and the more you trade, the worse your returns. Curbing trading frequency should be a priority for investors and policy makers, but clear research on who trades frequently is needed.

An international collaboration between Gizelle Willows, senior lecturer at UCT's College of Accounting in the Faculty of Commerce and Dr Daniel Richards, a lecturer in the Department of Accounting at the Royal Melbourne Institute of Technology University (RMIT) investigated the characteristics of frequent trading investors. In their study of 7 200 UK retail investors, they find that male and younger investors traded frequently. Also, investors who sought investment advice and investors who used stop losses also traded frequently.

“A profile of the frequent trader emerges. They tend to be younger and male, but also seek advice and use an automatic stop loss strategy to sell investments. Trading frequently could be part of an investor learning as being younger and using stop losses are associated with less experienced investors” said Willows.

However, the research also notes that trading frequently is not done by all. In fact, a minority of investors traded very frequently and the majority traded seldom. Richards stated, “Half of the trading was initiated by only 10% of investors, who traded about 69 times a year or over five times a month. This is vastly different to 80% of investors who traded only six times a year or once every two months.”

These findings are important because they show that to reduce trading frequency, only a few investors need be targeted and that such efforts should start with male, young, and stop loss using investors. The research also investigated if the use of the internet and phoning a call centre to trade was associated with increased trading behaviour. With the advent of internet trading platforms, trading by investors has increased and this effect was found in this study. However, phoning a call centre to trade was also related to trading frequently. While appearing contradictory, these findings suggest that investors who really want to trade will employ multiple mediums to do so.

The research has been accepted for publication in the Global Finance Journal and the article is available online. 

Story By : Gizelle Willows and Dr Daniel Richards .
 

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