Investor Psychology Pumps Up The Volume According To Study By Smeal College Professor

UNIVERSITY PARK, PA -- Thorough financial analysis is not the only driver of investors’ stock-trading decisions, according to a study co-authored by Steven Huddart of Penn State University’s Smeal College of Business, which found that some investors trade simply because the current price is above the range of prices at which the stock has traded over the past year. As a result, the volume of shares traded increases dramatically when a stock’s price reaches a previous high, with a similar increase in volume when a stock’s price falls to a previous low.

“Psychological Factors, Stock Price Paths, and Trading Volume,” reports that trading volume is higher in both economical and statistical terms when a stock’s price moves outside the trading range established over the previous 52 weeks. The volume of shares traded spikes during the week when price moves beyond the prior trading range, only to gradually return to normal levels. This strongly suggests that behavioral factors affect investors’ trading decisions in equity markets.

“It is surprising to find that the role of 52-week high in explaining trading volume is at least as important as that of major information releases like earnings announcements, or tax-based trading strategies such as dividend capture,” said Huddart, associate professor of accounting. “When a stock moves outside the trading range established over the prior year, there is, on average, a significant jump in trading activity.”

The study lends support to previous findings that investors set “reference points” (i.e., price points that motivate investors to buy or sell), and update these reference points over time. While prior research has shown that the price an investor pays to purchase stock can be a reference point, it further appears that prior highs and lows also serve as reference points for a significant group of traders.

Researchers Huddart, Mark Lang of the University of Carolina at Chapel Hill, and Michelle Yetman at the University of California Davis based their analysis on stocks listed on the NYSE, AMEX, and NASDAQ exchanges. The effects they document are strongest for NASDAQ firms.

Access the complete study at http://www.smeal.psu.edu/faculty/huddart/Abstracts/HuLaYe.shtml .

About the Coauthor
Steven Huddart's research examines how information and incentives affect decisions. He has examined the effects of ownership structure on corporate value; the determinants of portfolio choices made by investment advisers; the determinants of trading volume; the financial reporting, taxation, compensation, and valuation aspects of employee stock options; and the relationships between disclosure and insider trading.

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