APPROACHES TO UNDERSTANDING THE MODERN RETAIL TRADER

With the evolution of financial markets, a new key player is emerging in the form of retail traders. This comprises both novice traders who are uneducated about the workings of the financial markets as well as very savvy household investors. Among the areas requiring farther research is how well this sub-group of trader’s fairs compared to their institutional counterparts.

In recent times, several research inquiries have been targeted at this question. Key amongst these include, Brad Barber and Terrence Odean’s paper titled “The Behavior of Individual Investors” of 2013. In their research, they concluded that the scales are tilted against the retail trader who is bound to lose money in the long run. The paper which has gained global attention including a citing during the GameStop government hearings, utilizes the Calendar Time methodology to arrive at its conclusions.

In 2016 a group of renown finance academics including, Peter Swan, Wei Lu and Joakim Westerholm commissioned another research paper entitled, “Other People’s Money: The Trading Performance of Household Investors vs Delegated Money Managers”. The most interesting part of this research paper was in its findings which concluded that retail traders and investors have the competitive advantage over their institutional counterparts. One of the key factors attributed with this difference in conclusion is the use of different methodologies where one uses the Calendar-Time approach while the other is based on the Holding Period Invariant methodology.

A key point of departure for the two methodologies is their assumptions about the behaviors and motivation for actions by the retail trader. The C-T approach assumes the investor is only interested in making a return over a pre-determined calendar period while the HPI argues that the individual trader’s actions are driven by sale and purchase costs. This difference in approach is evident in one of the findings where Professor Swan and team found that the educated retail trader will shun trend driven price rises in favor of being contrarian and hence stands to make more in the long run given the volatility of speculation driven momentum.

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