Speculative Bias: Young, Male, Poor, Overconfident

Since 2012, whilst holidaying overseas, I visit the finance / investment section of bookstores as a barometer on their business climate. This year in Toronto, Canada, I visited Indigo Books in Fairview Mall. It had a number of books on technical analysis: reading price / volume charts to make investment and trading decisions.


TA was popular from the mid-1970s until the 1987 stockmarket crash and regained popularity during the 1995-2000 dotcom crash. Since about 2003 it’s been a dead methodology — at least in its vanilla, popular treatments — due to high-frequency trading. TA books however continue to sell to uninformed retail investors.


Arvid O.I. Hoffmann and Hersh Shefrin’s new study of 5,500 trader accounts at a Dutch discount brokerage between 2000 and 2006 has some sobering insights on TA and retail traders:


  • The study period coincides with the 2000-01 dotcom crash and the mark-up period of the 2003-07 speculative bubble in real estate.
  • TA appeals to young, male, poor, overconfident traders who want to speculate or who treat trading as a hobby.
  • TA traders had more concentrated portfolios than those who used fundamental analysis or professional advice.
  • TA traders had higher turnover; personal ambition; a short-term timeframe; and often did not consider transaction costs or taxation implications.
  • The average portfolio size in this study was $60,589 and the median age of traders was 49.79 years of age.
  • The 95th percentile included traders aged 70; who turned over their portfolios 98.19% per month; who did 43.06 trades per year (mean of 10.66 trades per year); who had 72 months experience or 6 years experience (mean of 40.21 months experience or 3.35 years); and whose portfolio was valued at EUR166,840 compared with a median of EUR15,234 and a mean of EUR45,915.


Hoffmann and Shefrin’s study suggests several things to me:


  • There are at least two identifiable sub-populations: (1) young traders who try to compound their risk capital to get rich; and (2) older investors using savings and retirement money.
  • Most traders last less than 3 years. Many over-trade or blow-up their accounts within 10-to-15 trades – in part due to very small trading accounts.
  • TA appeals to new retail traders who are really trading on rumours that can be traced back to Martin Zweig (“The trend is your friend”), Jesse Livermore, and the Edwards / Magee school of TA.
  • Interest in trading occurs at distinctive life stages: early twenties (get rich); late forties (save for retirement); and post-retirement (create a financial buffer for future spending).
  • Some trader success is due to the hot hand effect of winning streaks – which may in a social network influence a new cohort of traders – for what was more luck than skill.
  • TA traders attempt to mix indicators / signals and psychology (state management). Yet the real gap for retail traders is an understanding of transaction / execution costs.


Hoffmann and Shefrin’s study suggests several things to me about myself:


  • I’m in what Paul Fussell calls the High-Proletarian level of the middle class: university educated; but without the financial security of Fussell’s Upper Middle class.
  • I had encounters with financial markets from my early teens to my early twenties, but was not an investor in early life due in part to the adverse experiences of recessions and stockmarket crashes.
  • My serious interest in financial markets emerged after formative experiences around the 1995-2000 dotcom crash; the 1998 collapse of Long-Term Capital Management; and an encounter with Sir James Goldsmith’s life philosophy in 1995, re-explored in 2010.
  • I began research in 2009 and first traded on 5th August 2011 – days after a ratings agency downgrade in United States sovereign debt and into a Eurozone financial crisis.
  • I started with an account size in the 25th-30th percentile of the study – about $A5,600 to trade. I soon ran into psychological barriers about getting out of trades in a deteriorating market situation where I had hoped a market retracement might occur. I continued to hold positions despite passing my stop-loss limit.
  • This loss aversion led me later to more closely study the research on behavioural finance. I found that my initial trading hypothesis was correct — but the reason why was that it was also being ‘gamed by convertible arbitrageurs, prop desk traders, and high-frequency trading firms. I lost several thousand dollars before I exited the trade. In October 2011, whilst in Tokyo, Japan, I put the pieces together involving a series of trades by the Mitsubishi UFJ Bank which was warehousing trades for foreign hedge funds. This involved a Gurdjieffian shock – I knew what to do but emotionally I was unable to Act at the appropriate time to exit the trades. I sat in the Starbucks above the Shibuya Crossing and considered the implications.
  • This initial experience in live trading led me to pull back and examine what I knew about financial markets; what algorithmic and high-frequency trading was; why retail traders fail; and how professional traders work.
  • From 2011 to 2013, I bought most of the core literature on finance, wealth management, funds management, trading, behavioural finance, and market psychology to fill in some major knowledge gaps. This led to what will possibly be a post-PhD strand in my research program on the sociology of finance, and hedge funds / private equity funds as strategic subcultures.
  • From 2011 to 2014, I made a series of personal oath-promises to myself about personal self-sufficiency (Nihonbashi), long-run gains (Long Gamma), and shifting from a naive retail trader to understanding the institutional mindset (Toronto-Dominion).
  • Rather than trade I dealt with saving for retirement via employer defined contribution plans, employer co-payments, and legal tax minimisation strategies.
  • Rather than TA signals I began to study market microstructure (the study of price dynamics in order book flows) and money market flows between funds. Recently, I have downloaded several Springer books on high-frequency econometrics from a university database.
  • I found the major lesson about trading was about the psychology of decision-making and money management. These are skills I Needed to learn yet lacked.


In conclusion I fit one of Hoffmann and Shefrin’s sub-populations and past trading strategies. Reading their study is an important ‘reality check’ that helps me to identify what I can change to build a more resilient financial future. At least, I didn’t lose a million dollars.

10th July 2012: Day Trading 401(k)s

Software engineer Vlad Tokarev decided to day trade his retirement account. An LA Times profile documents the mistakes of Tokarev and other investors:


Minutes before the market closes every day, Tokarev buys or sells a mutual fund linked to the Standard & Poor’s 500 stock index. His goal is to profit from temporary fluctuations in stock prices, so he buys when stocks are falling and sells when they’re rising.


Wrong timing I: US stockmarkets tend to rally in the first hour of trade and the last half hour. Wrong timing II: buying at the end of day exposes the trader to overnight risk and possible market gaps. Wrong instrument I: a low-cost basket of exchange traded funds would be better than a mutual fund. Wrong instrument II: the S&P 500 is volatile and its index composition does not necessarily represent the market or sectors that perform well in current market conditions. Wrong asset allocation and decision biases: Tokarev is 49; wants to retire before 65; so his choice of day trading (availability bias) reflects an attempt to make-up for recent stockmarket losses (recency bias). Wrong risk management I: Tokarev day trades a third of his retirement fund whereas most traders recommend a position sizing of 1-2% of your portfolio on a specific trade. Wrong risk management II: Tokarev tells the LA Times, “”That’s what people usually say about day trading — but I don’t see how it can be dangerous.” This comment illustrates the irrational escalation bias, belief bias, blindspot bias, and the focusing effect. Tokarev also may not have factored in the  trading and execution costs, and capital gains tax implications of his day-trading. Instead, as Reuters’ Felix Salmon discovered, Tokarev appears to have based his trading strategy on a Wiley Finance book (Richard Schmitt‘s 4o1(k) Day Trading which has a bare-bones author-created website).


The LA Times article also quotes Wells Fargo customer complaints officer Joe Hansman:


Joe Hansman, 29, who handles customer complaints at Wells Fargo, shifts money among two conservative mutual funds in his 401(k) and the banking company’s own stock. He trades 10 to 15 times a month, steering money into Wells Fargo’s stock when he expects it to rally for a few day.

“When I told my wife about it she was really nervous … until I educated her on what it all entails and how poorly [the 401(k)] was performing before that,” Hansman said. “She’s still not 100% behind it but she said, ‘Just don’t lose everything. If you do I’ll divorce you.’ ”


In my view, Hansman makes a number of potential mistakes: trading expensive mutual funds instead of cheaper exchange traded funds; a home bias towards an employer in a sector (banking) that underperforms in a deleveraging (instead of using sector rotation); possible over-trading per month with higher transaction and execution costs; stocks that may have correlated returns and market beta exposures; and relying on swing trading without hedging. Handling his wife’s loss aversion and the potential, detrimental risks to his relationship are another matter: better invest in a copy of Diane Vaughan’s book Uncoupling: Turning Points In Intimate Relationships and a relationship therapist, just in case.


Neither Tokarev nor Hansman appear to have any background in finance or capital markets. Tokarev has a personal site with 401(k) day trading results.


Anxious Investors Day Trading With Retirement (LA Times)


Why Americans Won’t Day Trade Their 401K(s) (Felix Salmon)


Today in Awful Ideas: Day Trading With Your Retirement Fund (Gawker)


401(k) Day Trading (Vlad Tokarev)