Ordinary investors lean heavily on mental shortcuts when picking stocks – and it’s costing them.
A recent study, How Costly are Trading Heuristics?, examines 20 common heuristics, from favouring companies with short and easy names to buying at round-number prices.
Retail investors used 14 of the 20 heuristics more often than if they were choosing at random. The more shortcuts they used in a trade, the worse their returns.
Professionals played a different game. Big institutional investors only used three of the 20 heuristics more than chance would suggest – herding, peer influence and, oddly, the integer price heuristic (when you buy at round-number prices, like €10 or €100).
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It’s not surprising institutions copy each other or follow crowd trends, the study says, as this may reflect information-sharing or smart moves to trade with or against retail investors. Preferring stocks trading at round numbers, however, is “hard to rationalise”.
Whatever the reasons, when the professionals did use these shortcuts, they worked, and were linked to better outcomes.
As for ordinary investors, the researchers ask: why do people stick with losing habits? Sometimes because the harm isn’t obvious, they suggest, and sometimes because the process just feels good.
Still, the overall lesson is clear: what makes decision-making easier often makes investing harder.
