Taking Stock of Stockbrokers: Exploring Momentum versus Contrarian Investor Strategies and Profiles
Abstract ( Morrin, Jacoby, Johar, He, Kuss, Mazursky)
Two studies were conducted among professional security analysts to explore their patterns of decision making while managing investment portfolios. In study 1, a computer-based simulation, the analysts’ styles differed markedly, with most exhibiting either a momentum or contrarian approach, as indicated by responses to portfolio stock price changes. Study 2 used a verbal protocol procedure and semistructured depth interviews to probe the analysts’ thought processes. Momentum and contrarian investors were found to differ on a number of dimensions including price expectations, age, experience, raw performance, risk propensity, cognitive style, knowledge calibration, and strategy adaptivity. Implications and limitations are discussed.
Introduction (Via Morrin, Jacoby, Johar, He, Kuss, Mazursky)
Despite its prominent role in contemporary society, surprisingly little is known about the informationprocessing and decision-making strategies of professional stock market investors. A strict interpretation of traditional finance theory, with its focus on aggregate marketplace behavior, would suggest that investors are rational meanvariance optimizers operating in an efficient market where stock prices reflect their true values (Bodie, Kane, and
Marcus 1999). The nascent field of behavioral finance theory has challenged several of the assumptions of the traditional paradigm. Theorists such as Shiller (1993), De Bondt and Thaler (1985), and Shefrin and Statman (1993) have attempted to provide psychological explanations for the emerging empirical evidence of marketplace anomalies at odds with efficient-market theory. Our research explores which, if either, of these approaches is exhibited by the cognitive processing and investment decision-making of professional security analysts who take part in two stockpicking simulations.
The behavioral finance framework suggests that the collective impact of individual decision makers’ psychological biases may cause stock prices to be temporarily over- or underpriced relative to their true economic value (e.g., Shiller 1993). In support of this view, it has been shown that investors often overreact, for example, by excessively bidding down a stock price after learning of negative firm news. Graham and Dodd (1934), recognizing this possibility, were some of the earliest proponents of a contrarian approach to investment. They suggested that, because the market as a whole tends to overreact to negative news, some firms’ stocks temporarily become undervalued and thus represent buying opportunities. De Bondt and Thaler (1985) carried this notion further by suggesting not only that in vestors overreact to negative news but also that they overreact to positive news, resulting in overpriced stocks. Because of these tendencies, contrarian investors often expect that stocks that have fallen in value will rebound and that stocks that have risen in value will fall. Thus a typical contrarian investor buys out-of-favor stocks and sells popular stocks. Some studies have found support for contrarian approaches to investment under certain market conditions (e.g., Basu 1977).
Findings (Via Morrin, Jacoby, Johar, He, Kuss, Mazursky)
The findings from both studies reported here suggest that the security-analysis decision-making process is heterogeneous and multifaceted but not random in nature. In both studies, two distinct information-processing and decision making styles emerged: momentum and contrarian. These two types of investors differed on a number of dimensions. Most notably, they inferred opposite meanings from price changes of stocks held in their portfolios. Momentum investors generally expected recent stock price trends to continue. Momentum investors favored growth stocks, those that had been exhibiting continued price increases, whether or not the increases were justified by economic fundamentals. Idiosyncratic variations of this theme emerged, such as a focus on small-cap stocks or a search for peaks and troughs. The contrarians expected stock price reversals. They typically divested themselves of stocks they owned whose prices had risen and bought more of stocks they owned whose prices had fallen. The contrarians looked for bargains, stocks they believed to be temporarily undervalued due to the market’s overreaction to negative news, and they avoided glamour stocks, those they believed were overvalued, as indicated by fundamental factor analysis. Idiosyncratic variations of this core strategy were evident in terms of the metrics deemed most relevant to assess firm value (e.g., liquidity vs. earnings measures).