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Rs5,584 crore loss aversion, overconfidence drill a hole

Saturday, 1 December 2012 - 8:49am IST Updated: Friday, 30 November 2012 - 10:50pm IST | Place: Mumbai | Agency: dna

The figure is big enough for individual investors to take note. The loss is more than three times an average Indian saves every year. One study, in fact, puts it all down to a mental interplay.

It’s a mind game out there playing out in full effect. Yes, we are talking about the trading losses suffered by individuals like you while dealing with the vagaries of a stock market.  
And it seems there is a definite pattern to it. An extensive study to this effect singles out psychological biases, including an aversion to booking losses, causing the maximum damage.

To put the point in context -- the Centre for Analytical Finance (CAF) at the Indian School of Business (ISB) pegs this loss for individuals at a staggering `5,584 crore every year. “These losses are equivalent to 0.77% of India’s gross domestic savings per year. The total number of investors who traded at least once during this period is 25 lakh, or 0.22% of the Indian population,” Sankar De, Naveen R Gondhi and Subrata Sarkar wrote in a report.

This means if you are an individual trader in the stock market, you lose more than three times the money an average Indian saves every year.

But that is only the tip of the iceberg. The figure Rs5,584 crore does not cover commissions, transaction taxes and market impact losses. International research bears this out, which suggests trading losses account for only 27% of the total losses. “Assuming the same proportion of trading losses for Indian investors, the total losses for Indian individual investors would be around Rs20,700 crore, or Rs82,800 per active investor per year,” states the ISB report.

The study digs deeper, saying the behavioural biases boil down to a reluctance to sell a share with a loss even as there’s a willingness to sell shares that rise in value. Investors, it adds, also lose out due to the disposition effect and overconfidence. The former is the propensity to sell assets in which they have notched up gains and hold on to those which have got them a bloodied nose. The overconfident lot is at risk too primarily because these investors trade excessively and/or make riskier bets.

While individual players display the highest disposition coefficient, non-financial corporations are marked by an alarming level of overconfidence. “However, wealth losses due to both disposition effect and overconfidence are the highest for individual investors,” the study says. Worryingly, Indians are more prone to such behavioural vicissitudes than their counterparts in other countries such as the United States, China, or Japan. The upbringing and culture may have a role to play, suggests De. “(It is likely to be) more sociological than anything else,” he notes.

The findings may take on greater significance in light of recent policy moves intended to bring in more retail investors to the market. Take the Rajiv Gandhi Equity Savings Scheme, which offers tax breaks to first-time equity investors. Retail investors who put in up to `50,000 in equities are eligible for a 50% tax break on their investment, which is basically seen as a carrot. The scheme, however, comes with a lock-in of at least a year and up to three years, with some flexibility for the second two years, preventing the kind of churn that leads to investor losses enumerated in the study.

But what happens if they begin to dabble a little bit more in the equity market. The bigger question is how investors can be prevented from taking a hit. The answer may lie in better investor education, says De. But questions remain as to who would offer it and bear the costs and how investors can be motivated to take up education.

The study took into consideration trading data spanning the entire universe of transactions and order records of all 755 stocks listed on the National Stock Exchange over an 18-month period from January 1, 2005 to June 30, 2006. Of the 25 lakh investors, 24.6 lakh or 98% are individuals. They made 83.15 crore trades (61.8% of total trades) worth Rs17.9 lakh crore or 48.4% by value.

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