Why the House Always Wins: A Behavioral Perspective on Investor Trading in the Stock Market
Seattle University School of Law
April 5, 2005
Why do people buy and sell stocks? To make money, of course. However, greed is not the only reason people seek to accumulate and attain wealth. Some people want personal comfort, security, or freedom. It seems simple enough. Then, why do so many people buy high and sell low? Why do some people buy stock, but never open their account statements? Why do some people stay up all night in “after hours” trading obsessing over the same ticker symbol? Greed? Fear? While “greed” and “fear” are common (and often correct) responses to these questions, the answers go beyond these base emotions, and are often much more complicated.
This paper explores the motivations and rationales underlying the decisions of individual investors in the stock market. My purpose here is to examine widespread beliefs about trading behavior based on theories of efficient market hypothesis, risk aversion, anticipatory regret, realization, rational choice, and the legal implications involved in these theories. Finally, instead of advocating avoiding investing in its entirety, I will explore strategies to minimize investment risk. My purpose here is not that we should bring an end the use of our capital markets as a valid wealth-creating and wealth-circulating function of our entrepreneurial-oriented economy. However, if investors and securities lawyers understand the biases and flaws inherent in investor decision-making, then the trading activity that causes many of the suits and complaints against brokers, corporations, and institutions can be reduced or eliminated.
Number of Pages in PDF File: 20
JEL Classification: A1, K22, P34
Date posted: March 21, 2012