Impact Of Competence On Individual Trading In India
The goal of this chapter is to represent a crucial overview on the preexisting knowledge and researches regarding the factors related to determination of competence level of individual investors. The study of this chapter will do query for exploring various aspects which might influence competence level of investors. Both negative and positive feedback regarding these aspects according to preexisting knowledge will be accomplished. In this literature review chapter, an attempt for identifying all concepts, theories as well as definitions regarding chief topics and supporting documents will be accomplished. This process includes covering all the areas and various literatures which will ultimately create a clear conception of the topic under related research.
The traditional theories of finance have been assumed that each activity of the investor normally is aimed to maximize his or her business or utility. From the literature available regarding human psychology of business, it has been predicted that all economical activity of human beings are intended to maximize utility. Frequent trade is one important matter of concern regarding this topic, as it has been seen that frequent trading normally lead higher return from the investment. As far as the stock market trading is concerned, it has been clarified that only then investors generally trade when they think the trade can lead to expected utility. This might be one specific view but in general people are mostly influenced by psychological factors like overconfidence and competence effect. And also this frequent trading might result low return due to more transaction costs (Biais et al, 2005).
A huge number of psychological factors or biases are available that can influence the behavior of investors and also their decisions. This biasness may include overconfidence, home bias, sensation seeking attitude, competence effect, herding, anchoring, heuristics, etc (Graham et al, 2009). Brief explanations about all of these factors are introduced at the later portion of this chapter. The study about those above mentioned topics will try to reveal their actual relation with competence of trading.
In this chapter, a wide range of literatures are examined regarding trading behavior, mode of business and impact of alternate mode of business, comfort ability of investors handling various products. The specific goal of this chapter is to examine the compatibility of various factors that can determine competence level of investors in individual investing sectors.
Factors that can determine competence level of individual investors:
Trading behavior and factors which influence trading behavior
Miscalibration / Overconfidence as judgment bias
Sensation/Better than average effect
Social interaction/ Peering effect
Political factors and imbalances related to political polarization
Source of information which will ultimately lead investors to make investment
Alternate mode and motive towards business and risk factors
Behavior towards inherent risk and potential returns
Relation of competence with trading frequency
Comfort ability of investors handling various financial products
2.0 Trading behavior and factor which influences trading behavior
2.1 Psychological factors
In different sectors of business and investment, it has been proved so drastically that each and every person is influenced by his or her psychology. Either internet marketing or stock, in both occasions people are largely motivated by their psychology. Also there is a psychological tendency of people to follow the mob. For this specific reason to control minds of investors in stock market, Buffet (2009) said,” when the people are aggressive and greedy please be afraid, and when the people are afraid, you need to be aggressive”. This best business quote of the year 2009, ultimately fixes the issue that it is vitally important to understand psychological factors influencing trading behavior.
Basically human beings are not rational in nature. According to lots of psychological research and documentation, it has been approved that investor performance and their investment mode are strictly depend upon human psychology. And among all parts of business psychology, overconfidence is an important one due to its relation with trading volume and profit return. The theoretical model of overconfidence into the financial market has been approved that the overconfidence leads to higher trading level than normal. One famous model of (Delong et al, 1990) and (Wang, 2001) suggested that people with higher confidence level earn higher than the people with lower confidence level. Also there are some dilemmas regarding this interesting factor. People trading frequently would surely need more transaction cost. This transaction cost sometimes leads to decreased profit return (Gervias & Odean, 2001). Basically this overconfidence also depends upon the source of information related to business and also the volume of information. It has been approved by Oskamp (1965) that having more information will lead to more confidence among investors.
Basically the overconfidence literature means that one investor overestimating precision of information. (Kyle & Wang, 1997). It also often estimated as one large set of psychological finding. Overconfidence models are normally influenced by increased set of psychological results and also these results often are called as overconfidence. Also all of these models support that theorem that the overconfidence investors usually trade more than the rational ones. It has also been said by (De bondt & Thaler, 1995) that the key trading puzzle is overconfidence which is basically needed to be understood for better understanding of overconfidence and its relation to trading behavior. From previously researched documentations, it has been found that investors who are thinking that they are more skilled in terms of investment (but previous performance level could not support his or her belief) trade more often.
It has been also seen that overconfidence and trading volume is closely related. Only information alone cannot properly clarify the basic reasons behind trading volume. This is the result of no trade theorem which was formed by (Milgrom & Stokey, 1982). They have introduced noise and liquidity trading to clarify. (Varian, 1989) has said about the relation of high trading volume and differences of opinion. These differences of opinion can be raised by the differences in belief or by the ways investors understand the information. Also it has been said by (Harris & Raviv, 1993) that the differences of opinion is very common and can be found in day to day life of each and every people. Why this “differences of opinion” is in the number one position, it has been said by (Kandel & Pearson, 1995). They have showed that this particular matter helped to explain high level of trading volume. According to (DeBondt & Thaler, 1995) as well as (DeBondt,1998) have said that overconfidence is needed to be realized for good understanding of high trading volume. The main finding of this matter of fact is overconfidence. The people who misunderstood their investment skill trade more (Deaves et al, 2009) and (Hales, 2005). However, (Fenton et al, 2003) has also analyzed the interrelation between psychological and economic variables. Regarding this fact another matter of important thing is illusion of control. (Presson & Bennasi, 1996) as well as (Langer, 1975) measured this illusion of control by computer based work. (Puri & Robinson, 2007) have found out the relationship between optimism and major economic choices. Also Ben-David et al.  has made a test to find out whether managerial overconfidence is related with corporate policies and found that firms which have overconfident CFOs normally invest more. However, Benos (1998), (Daniel et al, 2001),), Hirshleifer and Luo (2001), Caballe and Sakovics (2003) are some principal models of overconfidence in one particular financial setting.
2.1.2. Miscalibration/ Overconfidence as judgment bias
Basically there is no strict definition of overconfidence. Miscalibration, overconfidence as judgment bias and also volatility estimation as well as better than average effect, these all are generally referred to the term overconfidence and its related factors.
Several analyses in the sector of investor psychology have been approved that only after one’s judgment can be called miscalibration while he or she would have the tendency to overestimate the precision of any information. However in case of security market, this miscalibration occurring from private source of information can be very effective and fruitful as well. (Odean, 2001) has proved that miscalibration is also a closely related term to excess trading volume. It has been seen very often that miscalibration results in excessive trading volume.
Let’s have a closer look at the following figure. It will reveal the level of profit per miscalibration quartile.
-50 (3rd) (2nd) (1st)
Average trading profits for each miscalibration quartile
Sensation/ Better than average effect
According to the world psychology journal, people generally feel that they are better than normal. This tendency is too common in almost max portion of people. Regarding this fact, (Taylor & Brown,1988) had important documentation which ultimately revealed that people generally have more positive review of the self and also this positive review is dramatically unrealistic as well as illogical. This “better than average effect” may be related to personal attributes or skills. However, this sensation of people having superior quality is called superiority complex in terms of psychology. And this superior quality has very important impact on trading volume and investment. Regarding this fact, it should be noted very cautiously that if max portion of people misjudge their capability and do decide in the wrong way, then “minimizing confidence level” and “do decide from brain not from heart” are the easiest ways to be gainer.
2.1.4. Competence effect
This competence does not introduce the physical skill. Instead of that it basically represents the intelligence level. Undoubtedly, more intelligent people can understand business well. For this reason, it should always be seen that more intelligent people are the gainer in business. Then where is the place for middle men? Here comes the most delicious information of this portion. It is proved that more intelligent people are more coward. According to this literature quote, lots of researches regarding business psychology also approve that more intelligence comes with more understanding as well as understanding of more risk factor which ultimately lead in less investment.
To examine herding behavior closely it was needed to apply theoretical and empirical papers. According to (Devenow & Welch, 1996), rational herding behaviors in the financial markets were needed to utilize the information acquirement facility, organize decision making in case of investments and do well arranged banking management. Some different opinions have been found by (Borenztein and Gelos, 2003) who have said that all mutual funds cannot be applied to apparent herding effects.
Basic facility of herding behavior is to correlate the returns in an investment portfolio which stands on same platform by mutual fund. But not always a stable fund guarantees continuous return. This suggestion was from (Froot & Seaholes, 2001) regarding mutual fund and stock returns. Basically, the overseas fund inflow incase of grouping or herding, depends upon price sensitivity of regional stock.
Basically, the experimental design in previous researches regarding impact of gender on trading behavior proceeds in two particular psychological ways. The number one is the competence which means perception or feeling of being knowledgeable or potent in some specified area and number two is overconfidence which means one specific level to which individual investors overestimate their own capability. Another closely related topic of this discussed matter is the difference between risk and ambiguity. Regarding the impact of gender on trading behavior, (Beyer & Bowden, 1997) had provided one excellent theorem. They said that women are less overconfident while that domain placed is male oriented. And also one thing is proved that financial markets are populated by more men than female. As far as the matter of investment is concerned, it has been shown that women are more conservative than men in case of investment. Also they are generally offered with less risky investment procedures by brokers. Another important experiment regarding this matter has been done by (Eckel & Grossman, 2001) and they provided supporting evidences that ensured that women normally are expected to be more risk adverse by men as well as by other women. However, it might be possible that the competence level is influenced by gender. There are thousands of field evidences that shows the women approach a lot differently that men regarding financial decision making. And also if it is measured in general, it can be found that women have portfolios with lesser risk than men. One key role player of psychological business, the overconfidence might also play an effective role here only if women perceive themselves as less well-informed than male in financial market.
Risk factor and gender, both of these factors are closely related to one another. (Eckel & Grossman, 2001) have found significant difference in result in case of choices between several risky prospects. It has been found by their experiment that women normally indicate a preference for less risky prospect. At the fact of dealing with the attitude towards financial risk, women reported a lower propensity than male.
It has also been found that in case of abstract gambling decisions, there are also gender differences. In low probability loss situations there has been no difference between male and female. In case of choices under ambiguity, it has found that women are always more uncertainty averse than male irrespective to familiarity as well as framing of cost. These types of contradictory results with risk experiments might be occurred by some sort of second order characteristics that also influence both male and female. Competence level or overconfidence might have a second order effect on particular decision making gender differences. All in all, it has been shown by previous researches that gender in general plays an important role in case of prediction while both sorts of individuals are confronted with uncertainty. By the way, overconfidence, knowledge and information lessen this difference at a greater extent. In case of all uncertainty formats, men are more risk or ambiguity averse while women are more risk or ambiguity prone. Among all low knowledge individual investors, men are more ambiguity prone and among all high knowledge individual investors, women are more ambiguity prone.
According to (Horvath & Zuckerman, 1993) had suggested that the biological, demographic and
Socio economic characteristics of one; together with his or her psychological structure affects the risk tolerance level. (Malkiel,1996) also suggested that an individual’s risk tolerance level is closely related to his or her household situation, lifecycle stage and also some subjective factors. There also existed discussion about some other factors that were closely related to individuals risk tolerance. These included years until retirement, sophistication of knowledge, income as well as net worth.(Guiso et al,1996), Hariharan et al (2000), Hartog et al (2002) decided that males are normally more risk tolerant than females.
2.1.7 Home Bias
Previous researches regarding home biases showed that investors in general tend to enrich their portfolio to domestic equity in stead of international equities. (French & Poterba,1991) and (Lewis, 1999).This term has been documented as “home bias at home”. Also it has been found that US firms prefer to have more business relation with local headquarters rather than others, (Coval & Moskowitz, 1999). Home bias also has been seen within a wide range of nations like Finnish, Swedish, Chinese and Indians etc. (Grinblatt & Keloharju, 2001).
The basic causation of home bias is information lack. To invest in foreign equity markets, one must have to understand the foreign account standards as well as legal procedures. But it has been shown than high wealth households normally have tendency to invest in foreign assets while low wealth have tendency to invest in local assets, (Vissing & Jorgensen 2003). One clear explanation of this fact has been given by Vissing-Jorgenson. They have said that the high wealth households have the capability to pay for information. But this ultimately does not tell the whole story. This is not ultimately related to only an information lack factor. Behavioral finance literature offers another explanation regarding this matter of concern. It has been told that people tend to remain more optimistic towards home market than the international market. And this might be one important key fact behind home bias. Also it has been documented that people normally tend to invest a big portion of their assets of retirement plans into their own company.
Investor competence does play an important role to explain the home bias. If an investor feels that he can understand the risk and benefits of investing in foreign assets, he more willingly will join the foreign market. And also the people, who feel incompetent for the foreign assets, will likely to retain themselves from taking any action. There is another interesting previous research made by (Huberman, 2001). He has said that the investors who are initially familiar with their home country have grown up a tendency to invest initially in the home country. But this familiarity is not all. (Heath & Tversky, 1992) said that this competence effect involves the feeling of an individual who is thinking that he is good at investing in general and in foreign stocks as particular.
This is a human tendency which is closely related to the competence level of individual investors. This matter of discussion is defined as the pain for making errors. This can even be small errors. It can be the feeling of outcome of a bad decision. If anyone wants to avoid the pain, he or she might change his or her behavior but that might be irrational. This regret theory would explain some stock market behavior of investors of postponing selling stocks which have gone down and also accelerate the selling stocks which have gone up. (Ferris et al, 1988) and (Odean, 1996) .
2.1.9. Self Control
Self control problems are important contributors to understand the competence level of individual investors. The reluctance of realize losses is also one kind of self control problem (Thaler & Shefrin,1981). Basically professional traders are very prone to let their loss get ridded. Without controlling of losses, it can cause significant amount change in individual’s investment. Previous researches also showed some investors who are aware of their losses but don’t want to close their account due to reluctance of realization of losses.
Kahneman and Tversky have shown that People basically are risk lovers in nature by their value function theory.
Figure: Kahneman and Tversy’s value function
Heuristics refers to the procedures by which usually people learn things for themselves by trail and error. This can also be defined as “use of practical efforts and experience for answering questions and to improve performance. This also ultimately leads people to develop “rules of thumbs”. But this has bad effects too. It often turns people to do more mistakes. (Shefrin, 2000)
In today’s financial world, information is spreading faster and for this specific reason, decision making in financial market has become tougher than ever before. In this stage, enhanced use of heuristics mostly is an inevitable approach, but it would not be beneficiary (Fromlet, 2001)
Anchoring might be defined as the decision making process where requirement of qualitative assessment is present and also these assessments are influenced by some internal suggestions. Internal suggestions mean suggestion from mind and from previous experience. People generally have some reference point in their mind which might be called as anchor. One example of this anchor can be previous stock price. Also in case of max portion of people, when they get new info, they adjust the past reference with the new one insufficiently. Anchoring basically tells how individuals are intended to focus on the recent behavior and also are giving less weight to longer time trends.
2.2 Socio-economic environment
Socio economic environment has vital impacts on factors which influence trading behavior. Factors like commissions, political polarization, social interaction and source and sufficiency or lack or information always play particularly important role in influencing trading behavior.
While the investors go for trade in financial markets, they have to face two types of cost factors; one is dealers bid ask spread and also another is broker’s commission. Due to increased level of market modernization as well as habituation of modernized online marketing, the bid ask spread has been reduced to a significant amount. By alternative trading system and also by online trading, investors can now avoid the number one cost factor. Institutional investors can also avoid the commission or can gain profit with low commissions. But in case of individual traders, always there were high commission loss and that also remains now. For this specific commission factor, trading behavior of individual investor can be influenced a lot. It has been researched using unique data set to examine how higher trading cost can make impact on trading behavior. Ultimately, institutional traders who pay almost no commissions share their profits with firm. But individual investors have to pay an increased amount of commission to make business and also they retain their loss or profit. These basic differences in trade affect the trading behavior of investors.
Generally both types of investors, institutional and individual, trade to generate profit. As individual investors pay an increased amount of commissions, they are intended to trade less often and also they generally trade with high risk due to reduced amount of trade. But in case of institutional investors, as they pay little or no commissions at all, they usually trade more often with less profit as well as less risk.
2.2.2 Social interaction
“People who interact with each other regularly tend to think and behave similarly”. (Shiller, 1995). In economical, sociological and psychological literature, peer effect or effects of social interaction has important outcome to influence the trading behavior of individual. A lot of theory suggests that individual can be influenced by the decisions of other through “Word of mouth (WOM)”, an interesting term in individual investor’s psychology. There are many evidences that the peer effect has influential and important effect while clarifying financial phenomenon like panic in banking sector as well as in stock market crash. Recent empirical examinations have also revealed that social interaction has strong effect on individual trader’s decisions.
Basically, peer or social interactions normally provide opportunities for exchanging important info via the word of mouth. And also by this word of mouths lots of investors are influenced to take important decisions of their business. But complex examinations regarding social interaction on the basis of country and society suggested that peer effect has different influence on different society. In an Indian society, people normally are counted as a group member rather than an individual. Surely the social interaction will be a lot in that society. Also the tendency of sharing information and the tendency of influencing by that information (word of mouth) will be greater. But if we think about USA, where people are self contained and viewed as autonomous individuals, this type of communication in general depends upon the length and strength of relationship. So it has been proved that countries with different cultures might have various sorts of impact on peer effects.
Political factors and imbalances due to political polarization
Internal, regional as well as international political conditions and also event can have immense effect on trading behavior of investor as well as currency markets. An exchange rate in currency market or trading rate in local market might become unstable and also can become susceptible during the time of political instability and political polarizations. There always have been found some new anticipation from new ruling party. According to that fact, individual traders always have to change their decision while political polarizations or introduction of new ruling party occurs.
Political upheaval and instability can have negative impact on nation's economy. For example, destabilization of coalition governments of Pakistan as well as Thailand can too negatively affect the value of their currencies and also tend to change the behavior of investors. Similarly, in one country experiencing financial difficulties, the rise of political faction which is perceived to be fiscally responsible can too have the opposite effect. Also, political events and instability in one country or in a region may also spur positive or negative interest in a neighboring country and, in this process, affect its economy and currency. This too affects the trading behavior individual investors.
Regarding this matter another fact is quite important. That is market psychology. During instable national or international political situations, market can move into a specific situation which is called “flight to quality”. This is one sort of capital light in which individual investors move their asset to any perceived safe haven. This perceived safe haven should have higher prices for the investors as well as higher demand. It has been seen in various countries that the US dollar, Swiss franc and gold have become traditional safe haven during political instabilities.
Sufficiency of Source of information which would ultimately lead investors to make investment
The sufficient source of information is an important part of motivating individual investors to make their investment in any specified field. This point is also related to home bias. In case of home bias, people generally intend to enrich their portfolio with local business instead of international. But the point behind this reason is lack of information regarding foreign market and lack of understanding about the foreign business method. It has shown by previous researches that if investors can get sufficient information about any investment sector from reliable source, their confidence rise up and also trade volume increase substantially. It is approved that reliable source and sufficiency of information have significant access into the mind of investors and can lead them to make investment and also can influence their trading behavior.
3.0 Alternate mode and motive towards business and risk factors
Motive towards business is an important part to identify business behavior and investor’s psychology. Behavior towards inherent risk and potential returns as well as Behavior of emerging market investment are important portion of this discussion. From the discussion of this chapter, we will try to find out the fact how motive towards business and also the mind of individual investors can affect the investor’s competence according to the previous research.
3.1. Behavior towards inherent risk and potential returns and its relation with experience
This study will focus on the attitudes and behavior of investors towards investment risk and potential return and also how these things can be related to competence level of investors. “The behavior of investor’s” research began in 1960s. But very few studies have been there regarding investors decision making under risk. Financial products investors often buy investment products by drawing on experience or by going through the investment appraisal process (Harrison, 2003). However, past investment experience as well as expertise of investors provides them the quality within themselves with risk awareness and so these have become significant commodity risk estimation factors. Also some personal traits like risk preference and personal experience which can affect risk assessment and awareness. The propensity for building up risk can also further affect the real behavior of investors, where risk can refer to how far decision makers are ready to extend their exposure to risk (Sitkin & Pablo, 1992). Risk perception too forms the basis of risk communication that means people facing uncertainty as well as ambiguity in according to the available information, construct inferences and also draw conclusions for them. In short terms, the risks people are prepared to take care are closely related to their attention and understanding, memory processes. These faculties decide people’s attitude to risk and their behavior in risk related decisions. Risk perception has been defined as risk assessment in uncertainty (Sitlin & Pablo, 1992). Risk perception is closely related to the competence level of investors and it can be determined the questions investors ask, organizational and management system as well as their familiarity. All of these factors are very important to determine risk perception and the competence level of individual investors. But the prospect theory basically does not deal with the past investors experience on future investment behavior and competence have developed one model for identifying the determinants of risk behavior. In this model, in addition to personal risk experience and preference, there is another point to be noted. That is social influence. In according to this model, social influence also has significant impact on individual investor’s perception. At later stage, (Sitkin, 1995) had extended this model with (Weingart,1995) and leads to the definition that risk propensity and perception are mediators in risk behavior in case of uncertainty decision making. Investment experience is also one very important factor which can influence the behavior of investors. Investors with increased experience have normally relatively high risk tolerance and also they construct their portfolios of higher risk (Corter and Chen, 2006). ‘The success and failure of past investor’ experiences influence the tendencies of the individual investor towards risk as well as risk perception, and further strictly affect decision-making behavior. Kathleen Byrne had shown that risk and investment experience always tend to indicate one positive correlation and past experience of the successful investment increases the investor tolerance of risk. Inversely, unsuccessful past experience can also lead to reduced tolerance to risk. However, past investment behaviors undoubtedly affect future investment behaviors as well as competence of individual investors.
Also over confident and optimistic minds are further forms of bias and these are closely related to risk tolerance and behavior towards risk. It has been found that individuals basically rely on personal past experience as one kind of foundation and also it comes from this that huge self confidence in the sector of decision making can originate. These types of individual investors with huge self confidence are always very prone to make inaccurate decisions. It has also been found that these sorts of investors basically rely on their confidence and do not care about the sufficiency of the information. Due to their personal trait, they always take decisions with believes rather that proper information. Optimistic mind is also another factor which can lead into investment loss for individual investors. Also there is another interesting matter of fact that over confident individuals failing too often feel that they have some inherited talent within themselves and also they grow up a tendency to over rate the self assessment quality. This overconfidence as well as optimism lead people to take inappropriate decisions without caring about proper knowledge, without caring about risk factors and also these things can be so harmful to even reduce the risk recognition power.
General investors are normally affected by their cognitive bias and also emotions in case of decision making. But this thing is not found within rational investors. It has been already proved that the act to engage in risky decision making during uncertain situations can never be considered as rational. (Tversky & Kahneman, 1992) showed that in process of assessment, people normally use some certain starting values as reference points. However, these reference points might be volatile values to which the subjects can add necessary adjustments. And also the KT experiment has demonstrated that this adjustment is usually not reliable. And also people who are confronted with different situations can have the tendency to produce different anchor values. Perceptions of risk can be affected by anchors, which also lead investors raising their returns expectations while given a bias or anchor of higher values. Objective consideration of investment risk and return of individual investors is proved to be one important point of consideration to measure the competence of investors. These factors can strongly be influenced by subjective framing impacts. Decision making processes depending on frames can cause problems which can ultimately lead an investor into different choices. The investors of financial markets normally receive a spectrum of reports and this report can be interpreted differently to recognize some important factors to do final decision making. It has also been found that noise traders have greater cognitive bias than the informed traders (Shefrin & statman, 1994).
(Wallach & Kogan 1961] were first to discuss about the relationship of risk tolerance and age.. (Yoo et al, 1994) had found that people decrease their risk exposure during retirement. According to (Yao et al, 2004), Financial risk tolerance is important in household portfolio decisions and the growth of household wealth as investors who tolerate higher risk tend to obtain higher returns over the long run. (Yao et al, 2005) has found that married people are less risk prone. He has done research among different races of people to find whether there is any relation between race and risk. He also found that there are interrelations between race and risk tolerance (Yao et al, 2005). According to (Warren & Stevens, 1990) used demographic and lifestyle analysis for segmenting individual investors. (Rajarajan, 2003) had found that people declined their risky investment when they moved up through different stages of their life.
The perception of investors of risk factors can also affect the expected outcome from investment. It has been understood quite clearly that investors never welcome risk factors but investments with higher expected returns must have higher risk factors. In this case, risk and reward are in one positive framework drawing correlation. Therefore, all the investors can not understand this fact of increased risk in case of chance of increased profit. Without this understanding of positive correlation between risk and profit, unskilled investors recognize expected return from a negative correlation to risk. In this case, this following figure might determine how risk perception, optimism and return expectation can affect the investment decision.
Figure: Model of the determinants of investment decisions
Investment over past experiences
Investment messages, Optimistic or pessimistic
Always people have shown their tendency to make investment in the face of uncertainty in spite of risk perception and also the tendency of transmitting and influencing decision making behavior. This decision making under risk factors can be found on the portfolio of the individual investors and also this risk perception affects the expected return and this investor’s behavior towards risk. This particular factor can help to determine competence level of individual investors at a great extent too.
4.0 Relationship of competence and trading frequency
It has been found that investors who feel more competent about themselves tend to trade more frequently than those investors who feel less competent about themselves. The reason behind this fact is quite understood. Investors who feel more knowledgeable regarding making financial decision should also be more willing to act on their own judgment (Graham et al, 2005).
It has been proved that all investors are not intended to trade too often (Odean, 1999) and (Barber & Odean , 2000). In addition to this comment, the previous research and evidence has been suggested that single, young and also male individual investors tend to trade too often (Barber and Odean, 2001). This high trading activity is because of their psychological bias as well as over confident minds. Overconfidence means overestimating the precision of information about the value of one financial security (Odean (1998), (Gervais & Odean, 2001). The overestimation or miscalibration might lead to significant differences in opinion from investor to investor. And also this factor in turn causes increased trading (Varian, 1989) and (Harris & Raviv ,1993).
But there are some dilemmas regarding this fact of miscalibration and trading frequency. According to empirical research of (Deaves et al, 2009) miscalibration does not lead into higher trading. But the contradictory and more effective data and research has been formed by (Glaser & Weber, 2004). They have shown the three aspects of overconfidence, such as: miscalibration, better than average effect and illusion of control. Here better than average effect means that people tend to think that they have higher capability and skill than other people. And the illusion of control means “the tendency to believe that one’s personal probability of success is higher than objective probability would warrant”. They have shown that the miscalibration does not ultimately lead to trading frequency. But “the better than average effect” leads to trading frequency which is also one important component of overconfidence. (Glaser & Weber, 2004) told that an investor believing him to be better than average is more likely to keep his or her opinion regarding future performances of a stock. In this case the investor is even well known that the other market participants disagree with him or her. This contribution to different opinion regarding stock ultimately leads to frequent trading.
Overconfidence generally increases the trading frequency by enhancing the heterotrophy of individual investor beliefs. It is not true that high competence level leads to high and frequent trading. When anyone feels more knowledgeable and skillful than the others, he or she then tries to bet on his or her judgment. In other words we can say that, in that situations they more likely to act on their beliefs as well as trade securities in stead of being more sensible. However, it can be told that investors tend to trade to more frequently when they feel competent.
5.0 Comfort ability of investors handling various products
Very few materials have been found regarding this important topic of comfort ability of investors handling various products. As it is important to have complete understanding about any product to handle those, this comfort ability of investors handling products is one important point to identify the competence level of individual investors.
Trail and error:
It has been found from previous researches that “make problem and get solution” is an important way to handle various products. It can also be called as trail and error. The capability to handle products and the understanding the market of that product is quite important for the individual investors to make profit. This can be done by trail and error method. But during this emerging world economy, it can be helpful to understand the handling of products and understanding the market, it will not be effective in making profit. So to go for the trail and error method, it has been proved from the previous researches that one individual investor should go for the smaller lot at the trail period.
To summarize, researchers have been made attempts to understand the factors which can determine the competence level of individual investor. In this chapter, after examining a wide range of previous literature and researches, the trading behavior of human being has been discussed and it has been seen that overconfident people having “better than average feeling” trade more frequently. And also with these types of people, the chances of losing investment and profit reduction are acute due to increased amount of self belief. This self belief ultimately leads them to neglect the knowledge regarding market summary and hypothesis, even though they know that their beliefs are uncommon and peculiar. Except this, lots of psychological factors like home bias, regret, self control, heuristics, anchoring etc have been discussed. It is also found that gender is an important matter of concern regarding decision making. Single and male investors are more risk prone than the female. They also tend to trade more frequently. Also risk tolerance level has found a bit lesser amount in female. It has also found that female investors are not really risk prone. A brief discussion about the impact of socio economic environment to determine competence level has also been thoroughly discussed. The impact of commission and social interaction has been discussed. And it has found that social interaction has major role to play to determine competence level of individual investors because social interaction provides the opportunity to share the knowledge and information regarding any investment. Facts about political polarization and its effect to competence level of individual investors have been told elaborately. About this fact, it has been found that competent investors have the tendency to move their asset into comparatively “safe zone” during international or national political instability. The close relation between competence level and trading frequency has been discussed. Regarding this it has been revealed that all competent investors do not trade frequently, it depends upon few specific factors. It has also been found that the motive of investors towards risk is an important fact to measure the competence level. After taking a close look to past researches, it has been established that those all points mentioned above have large contribution on competence level and to determine competence level of individual investors, it is a must to understand the above mentioned topics elaborately. Only after measuring the above criteria, the real picture of competence level of any individual can be determined.
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