Marketing managers across the world try to promote their products keeping in mind their target audience in the select markets. For example, a company engaged in baby food business, while promoting its products, is always focusing on the target consumer groups, and at best on those who are primarily associated with the purchase decision-making process. Similarly, in finance and investment, all the trading and investment strategies are formulated as per the requirements of investing community (read investors). What is different here from the way the consumer goods are promoted is that investment advisory services and trading strategies are designed for the biggies of investment community such as institutional investors and HNWI investors (High Net-worth Individuals). Retail investors are considered as noise traders or as the followers of institutional investors’ moves.
It is generally said that institutional investors’ trading has great influence on stock prices and returns. Their trading can cause momentum effect by way of high trading volume. This is explained by the facts that they have access to lots of critical information and are capable of conducting complex analysis in order to make informed decisions in equity markets. It is obvious that retail investors are not as much capable of incorporating the technicalities of investment analysis as compared to their institutional counterparts. But, are they so insignificant that they cannot be considered as influential in stock markets?
In this regard, an article published in Harvard Business Review (HBR, 2002) points out whether retail investors matter as far as stock price movements are concerned. According to the authors of the article – Kevin P Coyne and Jonathan W Witter – retail investors can be categorised into three broad groups for the purpose of profiling: high-velocity investors, medium-velocity investors, and low-velocity investors.
High-velocity retail investors come in the form of day-traders. But their entry and exit in the stock is so fast that they really do not affect the stock prices unless the price happens to be illiquid.
The low-velocity retail investors are the inheritors and the retired, who hold on to stocks for sentimental reasons or with an idea to benefit from the dividends and the capital appreciation. They do not have any impact on stock price volatility.
The medium-velocity retail investors are the most important group which creates some impact on the stock prices. They are the retail event betters who trade at a medium velocity, generally holding stocks for a few months to a year.
The role of retail investors in general and medium-velocity retail investors in particular cannot be ignored. It is important to understand the behaviour of the retail investors having significant magnitude of impact on stock price movements, so that their perception can be managed and, thereby, the momentum effects caused by their actions can be controlled. They are also the stakeholders of a company and a sound understanding of their behaviour will certainly of great help for the company to better manage its stock prices and the overall affairs as well.
Manage your irrational behaviour to make fortunes from equity investments!!
Filed under: Behavioral Finance |