Indian retail investors tend to lose in stock markets: ISB

Retail equity investors in India systematically lose out to other categories of players because they sell the winning stocks too quickly and hold on to the losing stocks too long, says a study.

It found that individual retail investors in India, numbering 2.02 million – largest in the world – consistently chase a zero rate of return on their stock investments when they make decisions themselves.

The study attributed the recurring losses to these type of investors to the ‘disposition effect’ (selling the winning stocks too quickly and holding on to the losing stocks too long) and ‘overconfidence’ (taking credit for good decisions and attributing bad decisions to luck) for three categories of investors separately.

The study by Hyderabad-based Indian School of Business was conducted under the leadership of Sankar De, Executive Director at the Centre for Analytical Finance, ISB.

It is based on the daily trade data of 2.5 million retail investors (given by NSE) who collectively carried out 1.4 billion trades, with a total value of Rs 37 trillion between January 2005 and June 2006, and is touted as the largest sample used in an empirical study in behavioural finance.

“We estimate that individual retail investors lost close to Rs 83.76 billion during the sample period of 18 months, from January 2005 to June 2006, or Rs 55.84 billion per year,” De said while releasing the report here today.

These losses are equivalent to 0.77 per cent of the country’s gross domestic savings a year, said the study titled ‘Do retail investors in India make rational investment and portfolio decisions?

The findings are based on the NSE data during the period and looked at the behavioural biases, investor performance and wealth transfer between investor groups.

“The total number of investors who traded at least once during this period is 2.5 million, or 0.22 per cent of the population. Put differently, 0.22 per cent of the country’s population lost 0.77 per cent of the total gross domestic savings during this period,” De said.

The figures are just the trading losses and do not include commissions, taxes and market impact losses, he added.

The co-authors of the study, funded by Citigroup and Goldman Sachs foundations, are Bhimasankaram Pochiraju, Naveen Reddy and Rahul Chhabra.

Other studies have documented that trading losses capture only 27 per cent of the total losses for individual investors.

Assuming the same proportion of trading losses for domestic investors, the total losses for them would be around Rs 207 billion, or Rs 82,800 per investor a year, De said.

The study only looked at the secondary market trade conducted by individual retail investors.

De said, “An analysis indicates that retail investors increase both buying and selling if their trades in the recent past are marginally profitable or barely in the positive territory, and decrease them if they are unprofitable or in the negative territory, ignoring transactions costs.

“Since on an average they lose more than they gain, trades of the retail investors end up being value-destroying for themselves and beneficial for institutional investors, who are usually more informed as well as more rational.”

Staying away from the market at a distance is the right way for investors – implying investing through mutual funds or other platforms could trim losses, he said.

What makes retail investors behave this way? The answer lies in two powerful behavioural instincts. “One, their approach to valuation of their investment options is based on feelings rather than careful calculation under which, what matters is the presence or absence of a stimulus, in this case profits, but not the size of the gains (losses).

“The second reason is the compelling influence of zero as a goal. The distinction between positive and negative numbers is of fundamental importance to human thought processes in many areas, not just investments,” he said.

After India, China is home to largest number of retail investors at 1.66 million followed by Finland (1.3 million), US (1.24 million) and Japan (1.17 million).

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