Are Professional Traders Too Slow to Realize Their Losses?

Publisher Website
Google Scholar
Abstract
Data on a U.S. proprietary stock-trading team provide evidence of the tendency of traders to hold on to their losers too long and sell their winners too soon—that is, the “disposition effect.” The group of traders studied earned more than $1.4 million in intraday trading profits, but they realized their winning trades at a much faster rate than their losing trades. This tendency lowered their profitability. When the traders limited their risk exposure by trading in small share sizes, in low-priced stocks, or during periods of low volatility, the discrepancy between losing and winning holding times rose. An analysis of intraday prices suggests that traders could increase trading profits by holding winners longer and selling losers sooner. The behavioral finance theory that predicts individuals will hold their losing investments too long and sell their winning investments too soon is known as the “disposition effect.” Past research has demonstrated this tendency for individual investors, but we used a unique dataset to test whether highly and consistently profitable professional stock traders are susceptible to the same behavioral tendency. The extent to which professional stock traders suffer from the disposition effect has implications not only for the traders' profitability but also, because of these professionals' trading frequency and large block trades, for the price discovery process for active stocks. The 15-member trading team we studied generated more than $1.4 million in intraday trading profits over a 68-day trading period in a downward-trending market. But we show that these professional traders held their losing trades much longer than their winning trades. On average, losers were held for 268 seconds with an absolute price ch...