Why do some investors trade stock frequently in the hope of getting rich, especially when it is easy to see that short-term trading is a losing proposition? The answer may be in comparing the behavior of frequent traders to that of buyers of lottery tickets, suggests Meir Statman, finance professor at Santa Clara University. A few years ago Statman coined the term “lottery traders” to describe a set of behaviors apparently shared by lottery ticket buyers and day traders who churned their stock portfolios.
Buyers of lottery tickets get back less than they put in because the state takes out a portion for its coffers before giving a prize to the winner. Stock trading is similar. “In the absence of trading costs, management fees and expenses, stock traders can expect to match the returns of an index of stocks,” Statman wrote. “But they can expect to lag that index once trading costs are considered.” Statman says some traders confuse their activity with stockholding, which is “a positive-sum game; buyers of stocks can expect to receive, on average, more than they spend.”
So why do we trade stocks or buy lottery tickets when the average player ends up a loser? Many surveys have shown that stock traders believe they will beat the markets. This unrealistic optimism is also displayed in other areas. For instance, surveys have shown that the average person expects “higher than average satisfaction in their first job, higher than average salaries and higher than average likelihood of having gifted children,” Statman wrote. Such optimism extends to expectations that we will not become crime victims, have trouble getting work or become ill, he added. Generally we feel that our future will be great.
“Because everyone’s future cannot be rosier than their peers, the extreme optimism that people display appears to be illusionary,” wrote two researchers in Psychological Bulletin. Traders and lottery players are often people who are “in the domain of losses,” Statman says. They have aspirations that are much higher than their incomes, and risk-taking seems to be their only way out. By contrast, successful people often reject these types of gambles because they don’t need them. One study found that people are more reluctant to exchange lottery tickets with others than they are to exchange other items, such as pens. Why? Because they say they don’t want to face the regret of giving away a winning ticket. Similarly, high-risk traders sometimes will hold onto losers, because they don’t want to face the regret of selling and then seeing their stocks recover.
Lottery and investment promoters capitalize on players’ emotions, Statman wrote: “Lottery players in advertisements are mostly winners even though most lottery players are losers in real life. Mutual funds in advertisements are mostly winners even though most mutual funds lag index funds in real life.” Investors should examine their own tendencies toward overconfidence along with their aspirations and emotions. They would be better served by making steady contributions to their savings plans rather than taking unwarranted risks.
