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Resolving a Paradox: Retail Trades Positively Predict Returns but Are Not Profitable

Published online by Cambridge University Press:  05 May 2023

Brad M. Barber ,
Shengle Lin  and
Terrance Odean
Brad M. Barber
Affiliation:
University of California Davis Graduate School of Management bmbarber@ucdavis.edu
Shengle Lin*
Affiliation:
San Francisco State University Lam Family College of Business
Terrance Odean
Affiliation:
University of California Berkeley Haas School of Business odean@berkeley.edu
*
sf@sfsu.edu (corresponding author)
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Abstract

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Retail order imbalance positively predicts returns, but on average retail investor trades lose money. Why? Order imbalance tests equal-weighted stocks, but retail purchases concentrate on attention-grabbing stocks that subsequently underperform. Long–short strategies based on extreme quintiles of retail order imbalance earn dismal annualized returns of −14.8% among stocks with heavy retail trading but earn 6.6% among other stocks. Our results reconcile the literatures on the performance of retail investors, the predictive content of retail order imbalance, and attention-induced trading and returns. Smaller retail trades concentrate more on attention-grabbing stocks and perform worse.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , First View , pp. 1 - 35
Creative Commons
Creative Common License - CCCreative Common License - BY
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence (https://creativecommons.org/licenses/by/4.0), which permits unrestricted re-use, distribution and reproduction, provided the original article is properly cited.
Copyright
© The Author(s), 2023. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

We appreciate the comments of Jennifer Conrad (the editor), Greg Eaton, Manasa Gopal, Christopher Jones, Eric Kelley (the referee), Christopher Schwarz, Jinfei Sheng, Paul Tetlock, Sheridan Titman, and seminar participants at the 2021 Miami Behavioral Finance Conferences, 2021 Chapman Finance Conference, 2022 AFA Meetings, Oklahoma State University, the University of Missouri, and the University of Toronto.

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