Heterogeneous Retail Investors and their Trading Behavior

Abstract

Efforts to understand retail investors and their trading behavior often consider them as a homogeneous group. I examine the extent and implications of differences in trading judgments within the retail class. I identify a sophisticated subset of retail traders (the “Savvy”) and an unsophisticated subset (the “Naïve”) who trade in starkly different ways in response to the same information. The Savvy type appear to respond to and process firm disclosures, buying good news and selling bad news. The Naïve type buy bad news and sell good news. I also explore the judgments each type of retail investor makes regarding the timeliness and costliness of their trades. I find that even the subset that appears to process and understand firm disclosures fail to earn returns that exceed their transaction costs. My findings suggest generalizations about “retail investor behavior” by academics and regulators may overlook meaningful and predictable differences within this investor class.