MILAN, Italy — Hitting it big on the stock markets is the dream of many casual at-home traders. It might seem that listening to the experts on popular financial shows and catching up on the latest tips from investor-centric magazines would help lead to a brighter financial future, but one study finds that ignoring the “experts” may be the best way to strike it rich with stocks.
Not everyone can live the dream of a day trader, but because the appeal is so intense, many stock traders gather advice from as many analysts and experts as they can. Researchers from Bocconi University in Italy, however, say that investing in stocks least-favored by market experts and pundits yielded five times as much money as the most-favored stocks.
Lead author Nicola Gennaioli looked at stock prices, stock dividends, and data over the past 35 years and compared it to common recommendations by stock market experts. His team found that investing in the 10 percent of stocks most recommended by experts yielded, on average, a three percent return per year. Meanwhile, putting money into the 10 percent of stocks least recommended by experts yielded an average yearly return of, believe it or not, 15 percent!
How ‘representativeness’ plays a role in stock market success
The analysts believe that when pundits select the next “Google” stock — that is, a new company showing strong growth — the experts get too optimistic about their stock prices. While there are plenty of companies entering the markets with prodigious growth, true “Google” stocks that only increase in value over time, are very rare. Stock price projections for these companies get too high, and the results are disappointing to investors who took pundits at their word.
Gennaioli and his team analyzed the stocks using the concept of “representativeness.” When successful stocks are represented more by stock experts, more people believe in the experts and that these stocks are plentiful and profitable all the time.
“In a classical example, we tend to think of Irishmen as redheads because red hair is much more frequent among Irishmen than among the rest of the world,” Gennaioli explains in a university release. “Nevertheless, only 10 percent of Irishmen are redheads. In our work, we develop models of belief formation that embody this logic and study the implication of this important psychological force in different domains.”
The authors say representativeness extends to more than just stocks, including social norms. For example, they point to the stigma of mathematics appealing more to men because of a slight prevalence of men being elite mathematicians. That prevalence, in turn, causes women to be less confident in their math abilities and make the fairer gender more un-representative.
The full study was posted online in September 2017 by the authors.
This article was first published on June 13, 2018.