You would be forgiven for thinking that retail traders and investors are predominantly day trading the stock market, with simple buy, hold and hope strategies, taking untold risks and generally losing money.
Those are very commonplace misconceptions, often repeated and reinforced in hallway conversations, in the media and in government hearings (like those regarding the GameStop Short Squeeze saga). Why? Because people are often referencing older research and methodologies.
What about newer research and different methodologies? They begin to tell a very different story. One of the most groundbreaking is from UNSW Professor Peter Swan, Wei Lu and Joakim Westerholm released April 16 2016 entitled, “Other People’s Money”: The Trading Performance of Household Investors vs. Delegated Money Managers” in which they analyze the entire equity portfolios of every investor on a daily basis in Finland during a 17-year period.
What most caught my attention was their difference in methodology which yielded very different results and insights than prior studies. The authors say, “we introduce a new methodology, dubbed “holding-period-invariant” portfolios, which is demonstrably superior to the conventional calendar-time methodology”.
- What is their “holding-period-invariant” methodology? Let me try to explain. It contrasts with the predominant methodology previously used in research called Calendar-Time (C-T) methodology, in which comparative trading and investing results are analyzed at the end of fixed calendar-time horizons, such as a day, week, month or six months, for instance. They explain in detail that this imposes a bias against informed traders who are contrarian in favor of uninformed traders who are trend followers.
- That is the essence of what we teach with our Core Strategy methodology at Online Trading Academy! To be an informed contrarian not an uninformed follower … in other words, don’t buy when everyone is buying or sell when everyone is selling … don’t buy, hold and hope like many people are doing … in fact don’t buy or sell at current price at all … instead, identify supply and demand zones some distance from current price, set a potential trade entry and exit and see if price comes to you. Be in an informed contrarian minority not an uninformed follower majority.
- By contrast then, what is Holding-Period-Invariant (HPI) methodology? It starts from the basis that trading performance can only be determined by a consideration of actual completed round-trip trades. So, they allow for the holding period to vary according to the actual round-trip timing.
- As they demonstrate, that makes a huge difference to the results, essentially turning the conclusion on its head, from households performing worse that institutions using Calendar-Time (C-T) methodology to households performing better than institutions with Holding-Period-Invariant (HPI) Methodology.
Referring to a prior Barber and Odean study, “The Behavior of Individual Investors” (2013), which is commonly cited in the media to reinforce the belief that retail traders and investors generally lose money (including in the GameStop Government hearings by the way), Swan, Lu, and Westerholm say that they, “reject [Barber and Odean’s] findings that households are poor performers in general”, and they go on to say, “we maintain that the standard findings of relatively poor household performance is simply a fiction based on the use of a biased methodology, namely C-T, that intrinsically and systematically penalizes informed traders who are contrarian in favor of the uninformed who are trend followers.” Indeed, they say that “we find that the households who choose to trade for themselves are economically and statistically the superior traders.”
Very interesting and I reached to UNSW Professor Peter Swan to ask for an updated comment which he was kind enough to provide (April 2021). Here is what he said:
- “For more than 40 years now, the world has been greatly misled by a research methodology that completely misrepresents the way in which investors think and act: the idea that investors aim to gain a return over some pre-specified period such as a day, a week, a month, or a lifetime.
- This research methodology, known as “Calendar-Time” (C-T), assumes that investors are rational humans when they make an investment, cognizant of likely returns and the cost of entering into the investment, including transaction costs, but are irrational robots when it comes to closing out their investment at the end of the day, week, month, or whatever calendar time period is specified by the research methodology.
- The reality is different, with investors deciding whether to either exit from that investment, retain, or buy more, depending on sale and purchase costs, the prospective returns from alternative investments or current and prospective returns from the investment already made. Any notional investment horizon belief held prior to the investment is now entirely irrelevant.
- Our Holding Period Invariant (HPI) methodology much better reflects that reality by analyzing round trip trades, which is simple to apply when you have the corresponding dataset.
- This HPI methodology unlocks the bias of the C-T methodology against informed traders who are contrarian in favor of uninformed traders who are trend followers. Informed investors buy when a stock is cheap and sell when expensive. Typically, the stock will continue to fall after the purchase, giving the false impression that the buyer was mistaken. Uninformed investors follow the trend and buy when a stock is rising. Typically, the stock will continue to rise after the purchase, giving the false impression that the buyer was right.
- The difference of methodology turns the conclusion on its head, from households performing worse that institutions using Calendar-Time (C-T) methodology to households performing better that institutions with Holding-Period-Invariant (HPI) Methodology.”
Given this revelation, I am puzzled why this doesn’t get mentioned in the media, which typically points back to the Barber and Odean study. So, I also asked Professor Swan about that and here’s what he went on to say:
- “One might reasonably ask why a Calendar-Time (C-T) methodology has become so dominant when our research shows it is biased. Perhaps it is because that bias typically favors findings that professional investors outperform, because they are uninformed trend followers, who do not own stocks but trade on behalf of those that do, collecting management fees.
- Our research using a Holding Period Invariant (HPI) methodology shows the opposite, that individual investors make far better trading decisions and outperform delegated investors. Perhaps because the former are more motivated to look after their own money?
- Your readers will need to weigh that up for themselves.”
From Professor Swan’s research, the secret is to be in an informed contrarian minority not an uninformed follower majority. The difference is to be informed about a contrarian methodology through education. That’s the essence of what we teach with our Core Strategy methodology at Online Trading Academy!
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