Resolving a Paradox: Retail Trades Positively Predict Returns but are Not Profitable
67 Pages Posted: 18 Feb 2021 Last revised: 22 Mar 2023
Date Written: March 15, 2023
Retail order imbalance positively predicts returns, but on average retail investor trades lose money. Why? Order imbalance tests equally weight stocks, but retail purchases concentrate in attention-grabbing stocks that subsequently underperform. Long-short strategies based on extreme quintiles of retail order imbalance earn dismal annualized returns of -15.3% among stocks with heavy retail trading but earn 6.8% 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 in attention-grabbing stocks and perform worse.
Keywords: Individual Investors, Attention, Retail Trading, Return Predictability, Order Imbalance
JEL Classification: G11, G12, G14, G40, G41
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