You Call That Fun? Why Individual Stock Investors Bother

Avanidhar Subrahmanyam studies how some investors’ gambling mentality affects share prices

There’s little argument that people — both professionals and amateurs — are terrible stock pickers. The great majority of professional fund managers fail to match the returns of the S&P 500 or other index they compete against, and surveys of individual investors show a vast underperformance.

So, why do so many individuals trade actively? For fun, it seems, even if their results suggest they’re masochists. A new study explores trading as a form of entertainment, and looks at the activity’s impact on stock prices. Nanyang Technological University (Singapore)’s Jiang Luo and UCLA Anderson’s Avanidhar Subrahmanyam used statistical models to build on previous studies of the mentality of traders and their effects on individual stock prices.

The authors begin with the assumption that trading is a type of gambling and they cite historical research indicating that the “uncertainty of the reward from gambling allows the secretion of dopamine, a pleasure-inducing hormone.” In other words, traders seek a chemical payoff as well as a financial payoff.

Because traders are “sensation-seeking personalities,” they would naturally gravitate toward the most volatile stocks in a given market environment, Luo and Subrahmanyam posit. That, in turn, helps fuel price bubbles in those stocks, ultimately leading to overvaluation and disappointing long-term returns for many of those equities.

Traders’ activity, then, could be seen as negative overall for the market if it stokes more speculation in stocks already viewed as high-risk. The authors note that traders also play a positive role by providing more liquidity in volatile stocks, thereby making it easier for other investors to sell.

It’s wrong, the paper says, to assume these traders act on “mistaken beliefs” or that they are overtly irrational. Instead, their desire for excitement means “they simply maximize a different objective relative to ‘traditional’ investors,” who focus solely on becoming wealthier.

The authors include a classic quotation from the economist John Maynard Keynes in 1936: “The game of investing is intolerably boring and over-exacting to anyone who is entirely exempt from the gambling instinct; whilst he who has it must pay to this propensity the appropriate toll.”

Luo and Subrahmanyam also show that individual-investor stock traders don’t focus exclusively on equities for the kind of stimulation they’re after: They weigh the relative appeal of other options, including casino gambling and lotteries.

“Specifically, when alternative opportunities are more attractive, volume in equities is lower,” the paper says. It cites a 2015 study showing that stock trading volume in Taiwan decreases as the total jackpot of a major statewide lottery rises.