Odean compares non-professional stock traders to tourists playing poker with the professionals in the smoky backroom of a Las Vegas casino.

“The institutional investors are the pros who show up in that backroom every day, and that’s how they make their living,” Odean said. “When you start trading actively, you are betting you are going to outsmart the pros, who are historically smarter.”

“I do think that people make money in the market through skill, but those people are not part-time, amateur investors,” Odean added.

Professor Odean should know.

He has been studying behavioral finance since 1993, and his findings don’t bode well for individual investors. “The average investor gets it wrong,” says Odean, the Rudd Family Foundation Professor of Finance.

Odean elaborated on exactly how wrong in the paper “Just How Much Do Individual Investors Lose by Trading?,” which he coauthored with Brad Barber of the University of California, Davis, and Yi-Tsung Lee of the National Chegchi University and Yu-Jane Liu, of Peking University. The paper is forthcoming in The Review of Financial Studies and is based on one of the most comprehensive sample of trading behavior ever studied: the trades by all investors on the Taiwan Stock Exchange from 1995 to 1999.

Individual Losses Add Up

According to Odean’s research, individual investors earn 3.8 percentage points less per year than the overall market. They estimated losses by individual investors totaled a whopping US$32 billion during the sample period — the equivalent of 2.2 percent of Taiwan’s gross domestic product or 2.8% of total personal income.

“The losses by individuals in Taiwan were shocking,” Odean says. “It’s a lot of money.”

At the same time, institutions enjoy a return of 1.5 percentage points higher than the overall market. Those findings contradict arguments made by some academics who maintain that institutions don’t make money in the stock market after paying for transaction costs.

When profits are tracked over six months, foreigners — foreign banks, insurance companies, securities firms, and mutual funds — earn nearly half of all institutional profits in Taiwan. “The profits of foreigners represent an unambiguous wealth transfer from Taiwanese individual investors to foreigners,” Odean stated.

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